Charter Cities: New Options for the Bottom Billion

Henry Kaufman Visiting Professor, Leonard N. Stern School of Business, New York University; Senior Fellow, Center for International Development and Institute for Economic Policy Research, Stanford University

SEBASTIAN MALLABY: (In progress.) Also importantly, please turn off those things that go beep and vibrate and so forth, because it messes up the sound system.

Here, we're here with Paul Romer, who is the Henry Kaufman visiting professor at the New York Stern School, but more deeply and broadly than that, has a very varied and interesting trajectory, starting as an economic theorist, mostly at Stanford; known in the 1990s as the father of new growth theory, which stresses that the traditional inputs into people's growth models -- labor, capital and so forth -- were inadequate, and that they left out the crucial role of ideas, and that once you started to understand that, it had big implications for how you could kick-start or accelerate growth, both in rich countries like the U.S., but also, importantly, in poor countries.

After that, Paul set up a -- an education software company, which he ultimately sold. He tells me that he didn't sell it at such a price that he's rich by Silicon Valley standards, but nonetheless it was very successful.

And then in the last two or three years, he's devoted most of his energy to something called the charter cities movement, which is what we're going to discuss.

So let's start there, Paul. I mean, tell us, you know, what is the charter cities idea, and what drew you to devote all your energy to it?

PAUL ROMER: Yeah. Let me actually take it in reverse order and say where this idea first came from. When I was in Chicago, when I was a professor there before I went to Stanford, there was a woman who worked for my wife and me. My wife was in a residency program, so this woman helped cook and clean in our house. And she lived in the Cabrini-Green housing project in Chicago, which as many of you know is one of the most desperate failures in our public housing system. And the question that struck me, when I saw her and these two young children she was raising, is why she didn't have a chance to move to a city which could offer simple things like relatively low-cost housing and low crime. She simply didn't have that option in the United States. And I started to ask why couldn't it be possible to create entirely new cities that could offer options like that for someone like her.

So that idea has stayed with me now for 25 years. And the application now is in -- is in the developing world, where there are hundreds of millions -- really, billions of people who are in the same position that she's in. And the charter cities movement is about taking seriously the idea that we could build entirely new cities that could present a different range of options to the least-advantaged people on Earth.

MALLABY: And this links back to your theoretical work on what drives growth, because as you explained, ideas are not merely new technologies. They're also, very importantly, rules, right?

ROMER: Yeah. Yeah. There's a -- there's a saying we use to explain that -- what's unique about ideas, their shareability. And I'm sure you all know it, but if you give someone a fish, you feed them for a day, but if you teach someone to fish -- you destroy another aquatic ecosystem. (Laughter.)

And what that suggests is, is that new ideas like trawlers and nets are things that we can share and use all over the world. But if we don't have advances in our rules, say that limit the catch in a fishery along with technological advances, those new technologies could do more harm than good.

In the developing-world context, the problem is often that the rules prevent valuable technologies. One I talk about a lot is just electrical light in the house, a hundred-year-old technology that still isn't available to many poor people all over the world. There -- that technology is not being made available to them because of the local rules that prevent it. And so I switched from thinking about how can we invent new improvements beyond electrical light, to thinking about how can we have improvements, innovation, diffusion of better rules alongside of innovation and diffusion of better technologies.

MALLABY: So in other words, the very fact that there are a lot of technologies that have existed for a long time, but yet are not actually adopted, suggests that it's the conditions for adoption that might matter more than the technologies themselves.

ROMER: Yeah, absolutely. And it's easy to think, oh, well, the poor people can't afford new technologies. But if you look at something like water, this ancient technology for delivering municipal water through pipes and taps, that technology's cheaper than the ones that poor people pay to get their water delivered to them in most slums around the world. So it's not that people -- poor people can't afford to pay for some of these modern technologies, but something deep in the system is preventing the development of something like a municipal water system that provides lower-cost, safer water.

MALLABY: Safer than having the water brought to you in some plastic container that --

ROMER: Yeah, plastic jug from a truck, from an unknown source.

MALLABY: Right. Right. Right. I mean, you use a very arresting image to get this point across sometimes, which is this photograph of kids doing their homework in an African city under a street light. And the kids probably have cell phones?

ROMER: Yeah.

MALLABY: Which is a newer technology than electric lighting. But they obviously do not have electric lighting at home. Otherwise, they would be doing their homework at home.

ROMER: Right.

MALLABY: So I guess this leads to the question, you know, people have observed for maybe 20 years, at the World Bank and other development organizations, that governance is very important, that rules matter, that institutions matter.

ROMER: Mm-hmm.

MALLABY: The question is: How do you actually encourage countries to improve their governance? I mean, and that's where you have some ideas as well.

ROMER: Yeah. Sure. So one suggestion I'm making at every opportunity is, let's take that word "institutions" and just stop using it. It's just too confusing and it's too vague, so think about rules. And when you -- every time you think about rules, think about laws and social norms about what's right and wrong. So the challenge is: How can we take an existing set of laws and norms, and change them to get to a new set of laws and norms?

I think one of the problems in the debate is we focused too much on the laws; we didn't think enough about the importance of norms. I think we also tended to assume that when there were bad rules in place, we wanted to look for a bad person to blame; like who's the bad person in charge? Who's the elite that's stifling opportunity for others? Let's find a bad person to blame, and then somehow change that person, and then we'll get to good rules. And I think that is just a dead end. It just doesn't correspond to the facts.

What we see are collections of people who all behave according to a given set of rules, and it's simply not possible, even for the leaders, to unilaterally change those -- change those rules in context. So we've got to figure out why is it hard for all these people, who can see that there are better rules, to not be able to change their rules, and then historically, what has actually worked to allow a change in rules when the -- kind of the frontal assault often fails.

MALLABY: So what's the answer?

ROMER: So the answer, I think, is this notion of a startup, where some group of people who are willing to try something differently say: Let us go off by ourselves. We'll develop both different laws, perhaps, but importantly, different norms about right and wrong. We'll reinforce that in our little culture that operates separately. And then, if these turn out to be a success and be better, we'll not only demonstrate to others that there's something which is better, but we'll also provide a mechanism where people can move from the equilibrium where one set of rules and norms prevails to this other one.

They can get socialized into those new rules, especially the norms, by exposure to them. And in a voluntary way without any coercion, you can move from one set of arrangements to another set of arrangements that are radically different, but at each step along the way, nobody was forced to change what they were doing here and adopt immediately what's working elsewhere.

MALLABY: So an analogy here would be between charter cities that you advocate in developing countries and charter schools in the United States. So one approach to school reform is to try to, you know, persuade people on the board of education to vote for a different -- choose a different superintendent and have, you know, reform from within.

ROMER: Yeah.

MALLABY: And then the alternative is to say that's really difficult because the existing school system sort of has a set of norms that are quite difficult to shift. So let's try reform from without through charter schools that sort of start out with new sets of norms.

ROMER: Yeah. So if you think about something like a KIPP school, it would be very hard to get a consensus with any existing school to shift this very different style of instruction and interaction with students at a KIPP school. But if you start a brand new one and say this is how it'll be run, students and teachers will go and try it out. But the charter schools lesson also has a caution for us, which is, I think, that if you don't operate at the right scale, you're not going to succeed.

I think that for dramatic change in education, you need to think at the level of a bigger system that probably is the scale of a city. So you need to change the whole governance structure, schooling in the city and how you measure performance and how you train people there.

So if you create these start-ups in a way which is too small and they're too dependent on the rest of the environment within which they work, they may be doomed to failure. And we've seen many countries around the world try to use this entity that they call a special economic zone, where they liberalize or change the rules in those zones, give firms the option to opt in there, so it has the elements I was describing before. But they're not self-sufficient; they're too dependent on the surrounding systems. And so they can't by themselves get the kind of success you could get if you took a city, which I think is, in many cases, the right unit to think about for doing things in a self-contained, comprehensive way.

MALLABY: And -- so another analogy is with the way that change takes place within business, and, you know, when IBM builds up a business, which is very, very good at selling big mainframes to corporate customers, and then along comes the personal computer and you've got to suddenly sell to individuals. It turned out that they had a lot of difficulty changing their business culture to be nimble enough to sell to individuals. And so another company sprung up from somewhere else, Dell or whatever, right?

So is that another good analogy with what you're --

ROMER: Yeah. There's -- I think there's a very fruitful analogy between cities and corporations, and they operate in an environment where they're competing with each other and start-ups can sometimes do things that the existing organizations can't do. And it helps, I think, guide certain intuitions that come to mind when we think about political change.

One of the very common reactions I get about a charter city is if you start at a brand new city with a particular set of rules, it might not succeed, it might not be a success like Hong Kong. To which my answer is, that's exactly right and we should start a number of them, just like we should start many small start-up firms. So the transition to the, you know, the computer on your desk and then the computer in your pocket, we think can remember the ones that succeeded; we don't remember all of the dozens or more that tried and failed. But the point at the level of the industry, and it will transfer to the world as a whole, is the cost of the failures is really extremely low. And the benefits of the successes are enormously important.

So we should be as open to the idea of brand new cities that start out and try and do things differently as we are to the options for brand new firms. And the one other thing that makes this so easy to do right now is that we live in a time where the world is desperately short on cities. You know, 3 billion people live in cities right now. In the next 30 years, 50 years, another 3 billion people will move into cities.

So we need to do urbanization on a scale that humans have never done before, more than we've done in all of history. And then the other interesting thing about this time is that once we've done it in this century, things will pretty much be over; we'll never again have the chance to influence the worldwide system of cities because we're going to reach a maximum population on Earth this century. We're going to reach probably a stable percentage of the population that lives in cities.

So one way or another, we're going to establish the system of cities for the whole world this century. And why not use it as a chance to try some things differently, do some things better rather than just grow by accretion all the -- all the many -- in many cases, badly run cities that exist right now.

MALLABY: I want to make sure that people understand how differently you're proposing, because you're saying not merely that there should be new start-up charter cities. You're saying that the people who run these cities ought to be outsiders, people from outside the country precisely to try to escape the existing rule set. You need, for example, if it's going to be Nigeria, that a consortium of European governments show up and start to run a new city, which may teach Lagos what it's done wrong.

ROMER: Yeah. This approach is one that could be used in many different places. So we'll talk -- come in a second and about Honduras where what you're describing is, I think, exactly what people in Honduras are expecting, that other governments will come in and help set up the governance for the new city they want to establish in Honduras. So think of it as a partnership between Honduras and a number of other governments who can bring both institutional credibility and administrative experience on basic things like the administration of law.

MALLABY: And we should just say for those who don't read the Central American newspapers every day that Honduras passed a constitutional amendment last week, which opens the way towards creating a charter city in Honduras and inviting foreigners to come in and administer.

ROMER: So we'll come back and talk about the specifics there in a moment. But I wanted to say that even though that might be the right model for Honduras, think about India right now. India might have a model where they create, entirely through their internal resources, brand new empty spaces where a new administration could be put in place and a whole new city could grow up.

So this idea of chartering an entirely new city could be something that's done entirely within a country, as China did with -- (word inaudible) -- next to Hong Kong, but in much of the developing world you have countries that are very small, that don't have the kinds of central resources that a country like India might have or countries like Honduras or many countries in sub-Saharan Africa. And there are kind of strong partnerships that, I think, could be exploited, will be critical to success. And the historical model that's worth keeping in mind here is that of Hong Kong.

If you think of Hong Kong as a piece of China where the British said, we'll do a partnership with China; we'll come in, we'll set up a new city here, and we'll see which Chinese want to come and live under a very different set of rules; Hong Kong was an enormous success for the people who came there and ultimately a success that I claim was pivotal in helping encourage the transition to the rapid growth we've seen since the late 1970s in China.

So -- and to bring it back to Honduras, they're very open to creating a new city where foreign partners might have a very decisive say on what takes place there.

MALLABY: And, you know, if one was to ask them, why would you give up control over some chunk of coastal land so that foreigners can come and run it for you, why do you think their political system has just voted with, I think, almost a unanimous majority in the congress there to endorse this idea? It's just counterintuitive that a country would hand over a chunk of land to foreigners. Why do you think that's politically feasible?

ROMER: So -- yeah, let's be -- let's be frank. This is a country which had a change in the leadership of the country in the previous presidency which was very irregular. And some people called it a coup. Others have said, well, you know, this person was breaking the law. But they had -- they had a president that was forcibly removed from office, a transition president and now a new set of leaders who were elected in the regularly scheduled elections.

But they understand that if they go to a major sovereign wealth fund and somebody with experience in airports and say, come invest billions of dollars to build a major airport here in Honduras; they understand that on their own, they're not going to have the credibility to say we can promise you that you're going to be able to operate in a stable environment for the next 50 years and your rights as an investor will be protected and the health, safety, water, electricity, all these things will be managed relatively well; they simply don't have the credibility to make that commitment.

But they understand -- in a way, it's just like if I went to someone and said, look, I want to buy a house. I'm a good guy. Lend me -- you know, lend me a million dollars and trust me. It just -- it would never work. I mean, I give up sovereignty over my house to a judge, and I say to the judge, I'm promising to pay these guys back. If I don't pay them back, then you've got to come and take my house away from me. Giving away sovereignty over my house lets me do a deal with the mortgage leader I could never do on my own.

And the government in Honduras sees that they're in exactly that same position vis-a-vis this enormous supply of worldwide financial capital and technological experience that's extremely eager to find places to invest in things like infrastructure all over the world. But right now, they're kind of like me and the mortgage lender on our own. They just can't get the deal done unless there's somebody who could guarantee that both sides will stick to the terms of the deal.

MALLABY: Paul Collier at Oxford, and I guess to some extent Steve Krasner, your colleague at Stanford, have talked around this idea as well. So I think, you know, what they've observed is that a lack of credible rules has been a major impediment to development, to the attraction of inward investment, as you described.

And they've advocated various sort of steps short of what you're saying. In other words, you know, if you sign up for the World Trade Organization, you're effectively adopting binding commitments from outside to promise investors that you will have sensible rules on commerce. And that's a kind of commitment mechanism that proves you're serious. And you're saying, you know, let's go beyond that and just take a discrete chunk of territory and hand over the whole control for 50 years, for some long period.

ROMER: Yeah, yeah. I think it's -- given the importance of this problem and the importance of the gains from trade if we could facilitate these long-term investments from the rich and fast-growing countries, the gains are so large that we should be willing to experiment with a number of different mechanisms.

But I think if you look at attempts that have been made to do this and you look at what kinds of things went wrong, it gives you pause about the -- you know, sort of the simple solutions others have asked -- others have proposed.

Let me give you some examples. Singapore was very successful in developing a city within its boundaries, and they started to ask: How can we go out and develop other cities like this in other parts of the world?

So they developed an extremely large industrial park, really a small-scale city on Batam Island in Indonesia. They also tried to develop a very large site outside of Shanghai in China. And in each case, it wasn't that some government came in and just expropriated the physical capital that they had put in place, but there were a series of subtle changes -- it's what I call death by a thousand cuts -- which took opportunities, which were very -- well, in Indonesia, it was very successful for a while, and then the government changed certain parts of labor regulation and just destroyed the viability of these investments.

In China, it was the opposite case, where they had put in all the infrastructure in the ground and then no businesses were willing to come because the local governments were sending all these subtle signals about things that -- things could go wrong in this zone if foreigners came and invested in the Singapore zone instead of one the city wanted to develop.

And I'm told there were stories like, you'd show up at this huge industrial park that Singapore was developing, and there'd be a big pile of dirt on the road blocking entrance. And you'd call the local government trying to figure out, who do we get to move the pile of dirt, and nobody knew. And Lee Kuan Yew would personally call Deng Xiaoping and say, you know, who could -- who do I got to talk to to move that pile of dirt? And, you know, Deng Xiaoping doesn't have any clue.

So the kinds of ex -- post-opportunistic behavior you can get subjected to here is subtle and has a lot to do not just with the law, which is important, to be sure, but also things like just local administration, the competence of the civil service, the transparency of the civil service.

And so bringing in a country that has experience with transparent, open, visible administration, regulation and legislation can be a way to quickly to the equilibrium that will really provide confidence for the investors.

MALLABY: So, I mean, just to sum up here, so supposing we take Honduras as an example, and the argument is that, you know, for umpteen years, World Bank missions have visited Honduras, and they've said, you know, you've got a governance problem; you need to do various kinds of reforms to fix your rules so that you get a better growth. And the problem is the entrenched elites or the system in general is too ossified -- it's like IBM setting its mainframes -- and it cannot make this switch to a better equilibrium of better rules.

So now you say, okay --

ROMER: Although, let me make one slight nuance there. Think of this partly as two sides, both of which are very afraid of being taken advantage by the other side. So you've got people with historical claims to large amounts of land who feel very threatened by peasants who are talking about, you know, like land invasions and seizures of land.

On the other hand, you have peasants and low-wage workers who feel like the landowners have taken advantage of special access through the legal system to get a position that is unjustified and they may do even more. So it's not just ossification, but a real fear on either side that if you created some government entity with some power, one or the other side is going to grab ahold of it and use it to disadvantage the other.

MALLABY: Right. But so for complex political economy reasons, it's tough to get the reform that would really stimulate growth. The creation of the better rules is difficult. And we've tried this for a long time. So now let's think outside the box, and instead of trying to get the Honduran polity to reform itself, let's have this charter city -- like a charter school, let's start off a rival, where you have on this coastal piece of land a consortium, and it's the Swiss government, and in alliance with the Dutch and Danish governments. And they come in together. They've got extremely good rules in their own countries. They understand transparency. They understand rule of law. They have fantastic rules in this new city. And now they're going to attract all kinds of investment.

But isn't the threat of the pile of debt outside the charter city, put there by the jealous mayor from the local Honduran city, isn't that still there?

ROMER: So first, in the sequence here, part of how you get that transparency and you deal with a lot of the internal problems is that the Dutch and the Swiss -- and I forget who was your third, but they all agree to appoint an individual who is like the strong mayor, the executive, who has lots of discretionary powers, a very clear mandate, but whose job it is to get things done and hold that person accountable. So, strong executive leadership is very important.

MALLABY: Are you a candidate?

ROMER: No. (Chuckles.) Nobody who's been a university professor is a candidate for an executive position. (Laughter.)

MALLABY: Even the son of a former state governor?

ROMER: No. But then this gets back to my comment about why cities are important and things smaller than cities don't work. If this is on a coastal location, with its own port, with its own airport, its own power system, you could have literal walls to grow up on the border with the rest of Honduras, and this little entity becomes a self-sufficient city-state that thrives, just like Hong Kong thrived when mainland China was going through the cultural revolution.

And so in the conversations in Honduras, what the president and the members of Congress understand is they need to create an arrangement which is strong enough so that an investor says to him- or herself, my investment there will be viable, in the sense that my rights will be protected, but also in the sense that this will be thriving city, no matter what happens in Honduras. Even if there's, you know, revolution and violence and chaos in Honduras, this is big enough, this is self-contained, this will thrive no matter what.

MALLABY: I'm going to open up in a second to members. I'll just ask a final question, which is, what's the chances, realistically, that any developed country wants to take on this responsibility? Because you're sort of positing that they would actually resort to force of arms to defend this enclave if they needed to. Otherwise, it's not credible.

ROMER: Yeah. I think because of the recent experience in Afghanistan and Iraq, developed countries are going to be very hesitant about military commitments that in some sense they feel like they can't deliver on. But this is a commitment which is easy to deliver on, and I think it won't be hard to persuade people of this.

The line in the sand where someone has to invade across that line to cause a violation is extremely important because it so clearly signals the violation of the law, of international law. So think of the invasion by Iraq of Kuwait. It was not hard to mobilize people around the world, because this was wrong and had to be resisted, and it wasn't hard to push it back.

So that's not the problem. The problem that we face right now is when there's a group of people where the mission is to try and impose order on people where some of those people never asked for these outsiders to come in and use violence to impose order. And so I think it's a radically different situation where there are some people who have said, we want to live under these conditions where you help protect our borders; and, you know, we as citizens of the city will staff, you know, the national service entity that helps protect those things; we just need your commitment of, you know, freedom of navigation of the seas and, you know, a little bit of support.

That's a radically different situation than trying to go in and force a security or policing system on a population where some people might like it but the others become, you know, the rioters in Haiti right now or the National Liberation Movement that resists our presence in Iraq --

MALLABY: People in the city have voted with their feet. They've chosen to be there.

ROMER: Exactly. Everybody -- this is why Hong Kong had such a different experience than most other colonial ventures by the British; that everybody who lived there came there knowing full well what the arrangements would be, and those arrangements had a legitimacy, because of that choice to opt in, that anything that's imposed against people's will can never have.

MALLABY: Okay. Let's open it up. Who's got a question? Mitzi, here in the front. So please stand and state your name.

QUESTIONER: I'm Mitzi Wertheim with the Naval Postgraduate School. I started working for IBM the day they had their PC, and I watched this transformation. They transformed themselves by selling off things. And I'm -- a little unclear to me how cities can sell off things. That's just a question.

I also have a question about scale. And if you're going to create a new city, one of the things you have to have is an initial investment to build the infrastructure. And it's not clear to me where -- because that's substantial, whether it's electricity or whether it's sewage or whatever. Where does that money come from?

MALLABY: The financing question.

ROMER: Yep. And your questions are very closely linked. So let me take the financing one first.

There is an enormous amount of financial resources around the world that is very interested in infrastructure investment. They see this as exactly the kind of investment they want, guaranteed high returns for decades into the future. And these -- like these sovereign wealth funds and private investors have been totally burned by chasing the wave for the last -- you know, the last decade. So there's a huge amount of financial resources there.

What's missing is an environment where they can make those investments and be free of political risk. So the money is there if you can create the -- if you can create the political entity that would protect it.

QUESTIONER: (Off mic) -- right kind of people.

ROMER: Well, so then think about how this plays out. The airport, who would finance an airport? If this is going to be a city of 10 million people, lots of people would agree to finance the airport in exchange for the ability to just collect the landing fees there for both the passengers and the cargo that come through. Who would build the power system? You know, a firm that can charge for the electricity at the kind of rates we pay. Who would build the water system? So there's an awful lot of investment that could come in just based on self-interest on the part of the investors.

But what you need is a government which is strong enough to do two things: one, ensure that the initial deal that you make with the investors is respected from the side of the residents and the fee payers and the government; but on the other side, equally important, to guarantee that the firms stick to what they promise when they come in, because in many developing countries, they promise the world, they come in, they're the monopoly provider, and they say, oh, you know, I know we said X, but you're going to pay, you know, 2.5 times X or you don't have any water tomorrow.

So you need a strong government to protect, because both sides can behave badly in this kind of arrangement.

Now, one other thing. Who's going to pay for the schools here? Outside investors are not going to come in and pay for the schools. If you think about a tract of land, like a thousand square kilometers, which is what we're talking about here, it's about -- it's bigger than the size of either Singapore or Hong Kong; and you think about what that land would be worth -- it's worth nothing now, essentially -- you think about what that land would be worth if there were a city like Hong Kong or Singapore that was built there, it's just hundreds of billions of dollars in potential gain in the land itself, separate from what you have to pay for the buildings, the ports and power system and so forth.

There's a way to give the governing entity the returns on the value it's going to create in that land and use those returns as the way to pay for the basic services like policing and education, minimal health care, that make this a really attractive place to come to. So there's a way to do this that doesn't require any charity, that just harnesses mutually beneficial exchange, as long as we create an environment where people can safely contract with each other and do deals.

MALLABY: I should point out that in the U.S. foreign assistance context, we have two things going on right now: a big, announced desire to reform USAID and have new ideas, which is good for your idea; and a huge budgetary constraint, which might be good for your idea too.

Another question. In the middle.

QUESTIONER: Bob Winter with Arnold & Porter. What is the relationship between the new city-state and the rest of Honduras? And what happens if people join the city-state and then decide they really don't like it? And does the government of Honduras gain anything in the way of taxation, and therefore does it in fact have some control over the city-state?

And finally, trying to understand how this would operate in practicality, is the city-state run by an executive with, you know, a number of Danes and the like, or is it democratic? And if it's democratic, what do you do if you have the types of divisions within the city-state that you have in the rest of Honduras? And what leads you to believe that that will radically change?

ROMER: So let me work backwards again. All of this is under discussion right now. Very little of it is set in stone. To just be clear about the procedures here, there is a constitutional amendment which specifies what the Congress in Honduras can do in creating special development regions. And that specifies a few items about what are the powers of the Congress in that region as opposed to what would be the powers within the region. And the thrust of the amendment is to create enormous flexibility for some new government entity in that region to operate independently of the government.

So I guess I -- and now going back to your first part, things like fiscal transfers between the two have yet to be worked out. They haven't -- there's a second stage, where they have enabling legislation for a particular site, that will probably specify things like the involvement of partner governments in, say, appointing the strong mayor. And there may be some arrangements for fiscal transfers back and forth. They may decide that the smartest thing for Honduras and Hondurans is to not require any fiscal transfers at all and just make sure this thing right next to them is a big success.

Now, the Hondurans that I've spoken to think that in the early stages, it would be better -- it would be more attractive to Hondurans if, when they go to this city, they don't have a vote over who that executive in charge of the city is. So both some of the rich land-holding families who might want to invest there, some of the peasants who are landless and very frustrated about that, both sides may find it more attractive to go to a place where they know that the mayor was picked by the Danes and the Swiss rather than selected through some democratic process which could lead to one side taking advantage of the other side through, you know, patronage and militias and all the kinds of things we see around the world.

So the people in Honduras will make this call, but they may say not only will the foreign investors be happier if there aren't elections for the mayor in this place for many years; the firms who come in and hire people may also be more comfortable; the residents may actually be more comfortable, as well, going some place where they don't inject the kind of insecurity they've had to live with for so long in Honduras in this new place.

MALLABY: So when you go there, you don't get a vote, but by virtue of having gone there, you have already voted with your feet.

ROMER: Yeah. And by the way, I think it's absolutely essential for any country who sets up something like this, and for the world as a whole, to insist on not just a de-jure but a de-facto exit option for people, that no one should ever be trapped in one of these places. So they vote with their feet to come in, but they should always be free to leave if they don't like what they find.

MALLABY: Instead of the choice that cross-border migrants make all the time. They leave Honduras; they don't go to a charter city because there isn't one; they come to the United States, they don't get to vote here, at least at first, and they've chosen that. They've opted in.

ROMER: Yeah. I mean, if you think about the choice right now, a Honduran who comes to the United States typically has to leave his family behind -- suppose he's going to come work in construction. He leaves his family behind. He's going to live illegally in the United States, has no hope of voting for who the mayor is wherever he lives in the United States, and he's got a one-in-seven chance of being kidnapped and held for ransom by a Mexican gang on the transit to the United States.

So it's not very hard to imagine that a place close by, where he could take his family, where he could live as a permanent resident and have the same kind of economic opportunity he's seeking in the United States -- it's not very hard to imagine it being preferable to go to that place as opposed to come to the U.S. the way they do now.

MALLABY: Yeah, a question right here.

QUESTIONER: Hi. Rebecca Patterson, the Kauffman Foundation. I was just wondering if you could talk about the opting-in process, if there is some sort of selection criteria that you can -- you prevent spoilers.

ROMER: Again, this is something where the Hondurans will have to make their own choices. There are a few things that economic theory suggests going in. There's an issue like the one we face about health insurance and pre-existing conditions. You would be dangerous to start this by saying, well, for example, we guarantee that we're going to provide very large transfers for anybody who has some kind of disadvantage, because what happens is then you select a whole population that are committed to transfers.

In the same way, it'd be a disaster to say, "Well, we, the Honduran government, are going to give a whole bunch of tax concessions and payments for firms that will come and create jobs," because then what you do is attract a whole bunch of firms who are committed to, you know, bad equilibria with -- you know, with transfer payments and rent-seeking from the government. So you've got to set these rules up so that the people who come in come in because they want opportunity and they want to -- they want to work.

When you think about security issues, another question that I've raised is whether or not they want to think about, in some sense, the burden of proof when you ask someone to leave to be different from the burden of proof when you say, why not incarcerate someone for violating the law?

And I think they may well opt for the notion that, in principle, this city is available to anybody from Honduras, and they're committed to the idea this -- that this will be for the whole region as well, but that there may be conditions for coming to this place, like participation in something like national service, and conditions in terms of attachment to the workforce or going to school. And if you don't meet those kinds of conditions, you may just be asked to leave. You know, they might decide it's simply not an option in this city to be unemployed and not in school and just a source of -- a source of potential problems.

MALLABY: Another question. Fred here.

QUESTIONER: Thank you. Fred Tipson with the U.N. Development Program here in Washington. I wanted to ask you whether you'd looked at Jeff Sachs' Millennium Villages approach. But actually, I lived in Hong Kong twice, and I -- the analogy is fascinating, but it strikes me as --

ROMER: To what year? What years?

QUESTIONER: I was there from -- let's see: (1988/1998 ?) -- '91 and then '98 to 2001. So ten years apart.

ROMER: So ('88 ?) to '91.

QUESTIONER: Both before and after the transition.

ROMER: Okay. So you had -- okay. (Inaudible.)

QUESTIONER: Yeah.

But the question is really which analogy to Hong Kong's history is the relevant one. Because, as you know, in the beginning, the Scottish trading houses were the ones -- and the conditions for people were abysmal for, you know, most people in Hong Kong except for the British civil servants.

But then if you're talking about the take-off period, really so much depended on the influx of these powerful families from Shanghai who ran the businesses. And, of course, Hong Kong was a managed economy by the British -- still is a managed economy. And the notion of local people just had a whole -- you know, there -- a lot of people were in transition when I was there. People were getting their green cards to be able to have an exit strategy. It's a city that was -- that basically for the take-off period was building on the ability to manufacture in China, very cheap labor, almost forced labor conditions that entrepreneurs in China were able to take advantage of.

I just don't see these analogies coming true in Honduras. But I know you've probably thought deeply about the analogy and how it -- how maybe it does instruct how this can be done more effectively.

ROMER: Yeah. Yeah. I think the right -- the right picture to have in mind is Hong Kong in 1950, because then the prospect of the takeover by mainland China was very distant, so everybody was anticipating British administration. And this was a place where somebody from mainline China could come and get their first paying job, their first job with a wage -- and that's almost always in garment assembly -- I mean, we just see this over and over again all around the world -- then later into something like toys, light manufacturing. I mean, most of us in this room can remember what "Made in Hong Kong" meant when we were -- we were kids.

Those people didn't earn very much. They lived in tiny apartments. But that job and that apartment was a big step up for them from what they had on the mainland. And that job in particular, especially a formal-sector job with a firm that pays a wage and follows rules and enforces certain kinds of patterns of interaction with other people in the firm, there's a training -- an on-the-job education that comes from that kind of job, which is incredibly important for people who want to improve their quality of life.

So I think we have to be very open to the -- to the -- to the economic reality that the first jobs that most people will hold in, say, this new city in Honduras will be jobs that pay very little to be competitive with the worldwide garment industry and light manufacturing. They're going to live in tiny apartments, by our standards, fewer meters per person than we would -- we would ever want for ourselves.

But when they go there, they'll be telling us they're going there because that's better than the other options they've got, and because they know that there's a future like the future for all the -- virtually all the Chinese who went there in the 1950s who all rode the wave up into incredibly rapid increases in average income per capita.

MALLABY: But you could extend the point, I think, because if the analogy is Hong Kong in 1950, then by the time Fred moves to Hong Kong in the late '80s and there is -- then this interaction with Shenzhen and the building up of the hinterland and the interaction between the capitalists in Hong Kong and the sweatshops, and if that's -- that's also part of the vision here -- right? --

ROMER: Yup.

MALLABY: -- that the charter city ultimately does create spill-overs into the hinterland which are going to be good for the hinterland.

ROMER: Yeah. But, you know, and who knows how long it might take, but 20 years, 30 years, this charter city in Honduras might look like Hong Kong today or New York today, and there won't be any garment assembly or any toy manufacturing going on there, but it will now be a service and cultural and finance center which is serving other locations where people will still be going to get their first job in manufacturing. And those could be other locations adjacent to this location in Honduras, but it could be other locations that are just a plane ride or a ship ride away throughout Central America.

MALLABY: Right over here. You've been very patient. Thank you.

QUESTIONER: I'm Maureen Lewis from the World Bank. And I like out-of-the-box thinking, and I think this really falls under that category. And it's a very interesting idea.

I do have a couple of worries, having spent some time in Latin America.

One is that I gather there will be courts, but there don't need to be any jails, because you can send people away. I mean, it -- that's sort of a shorthand. But --

ROMER: My guess is there probably will be jails, too.

QUESTIONER: There will be jails. Okay. So you do have that cost.

But I think fundamentally I worry about two things.

One is the economic -- the economic viability of it depends on labor, basically, because you're going to bring in the capital, and you have the land, so that there's a little bit of a constraint there, given the problems that Honduras has had in the past in terms of a labor force that is not really prepared particularly well. And the garment -- the garment industry is very competitive worldwide. It's really hard to break into that, for many reasons that you can probably explain to me better than I can explain. That's one.

But the other issue that I do come back to is the political stability and what the guarantees are for investors against political upheaval. All it takes is a Chavez, and today you have this gleaming city, and tomorrow you're, you know, at the mercy of somebody who really is not going to abide by any of the rules that a previous government agreed to.

ROMER: So you have to -- you have to kind of scenario plan for something like this. So -- this won't happen, so I can use his name, but you know, Michael Bloomberg agrees that being president is really not very interesting, and Michael Bloomberg takes over and he's running this -- he's running this new city in Honduras. He gets to build a brand-new city from scratch.

And he's got commitments. He's appointed by the Swiss, the Canadians, the Norwegians. He's got investments that brings in the infrastructure and then the firms.

And remember, this isn't just a problem of getting access to cheap labor. The thing about cities is they create enormous value when they're well-run. So you're getting all of these gains from bringing millions of people in and letting them interact with each other really, really intensely. So that's the value he's creating.

And then Chavez takes over the rest of Honduras. You know, Bloomberg goes: Fine. You know, cross the border -- you better be shooting when you cross the border, because you can't come in. And he just -- he keeps running his city; goods are coming in and out of the port; planes are taking off, flying in and out, just like Hong Kong during the Cultural Revolution. You know, what's the problem?

Chavez says: Well, we -- you know, we tore up the old constitution. This is our land.

Bloomberg says: Okay. Well, what are you going to do? Drive across the border shooting?

MALLABY: I think it's worth sort of underlining a point you, I think, were getting at earlier --

ROMER: Yeah.

MALLABY: -- that there's a hierarchy of international commitments, some of which are violated very, very easily --

ROMER: Yup.

MALLABY: -- and don't have much credibility, and others to do with clearly demarcated borders. In fact, the record is that when people violate those and they come across shooting --

ROMER: Yeah.

MALLABY: -- then there is an international response.

ROMER: Yeah. I mean, the reason I'm sort of being provocative about this is that people don't -- I mean, almost nobody, except for, you know, Saddam Hussein in Kuwait, has tried this ploy recently. The only other one was the Argentines trying to take back the Falkland Islands.

So it's really implausible that any -- you know, that any leader in any surrounding region would try and mount a military invasion, because even countries who hadn't, say, signed on as, you know, people who help appoint the mayor are going to react to such a -- you know, such a brazen attempt at, you know, violating, you know, the sovereignty or the integrity of a political jurisdiction.

So I think what you should worry about are not the invasions but the subtle -- kind of the potential for death by a thousand cuts. And so, you know, this is exactly what people are talking about in Honduras right now with the constitutional amendment. Constitution reserves for the government of Honduras control of the air -- the air rights over this -- over this area. That can't be delegated under the constitution without more changes than they wanted to make to the -- to Bloomberg. So Bloomberg can't control air traffic over his city.

But Bloomberg can go out and sign treaties with many nations around the world that guarantee free passage of air traffic, just like the treaties we use that guarantee innocent passage through maritime waters. And then if the Chavez-like leader wants to say, well, our air traffic guys aren't letting any planes take off in and out of your -- you know, in and out of your city, well, now he's got a beef with nations all over the world because he's violating treaty commitments to all of them, not just an internal dispute with this -- with the city. And then -- you know, then what's to stop Bloomberg from just saying, you know, we've got our own air traffic controllers now; we direct the planes when to take off?

So you can -- you can scenario plan fairly specific kinds of circumstances here, but the overriding thing you can come back to is that there's no economic reason why a city like this couldn't be set so that it can be totally viable regardless of what happens in the rest of Honduras. And so if you plan for what would happen if the rest of Honduras plunges into chaos, then you can be confident that actually it'll never happen. Yeah.

MALLABY: (Inaudible) -- in the back.

QUESTIONER: Hi. Amanda Sloat. I'm intrigued by the idea, but it seems if you take a more cynical approach, it smacks a bit of postmodern colonialism, that you have an underdeveloped country and so you have a bunch of wealthy Western nations with spare capital looking for an easy place to make money and have the cheap labor and come in and effectively build a town off the back of a poorer country. So I'd be curious to hear your response to that

And second, how some of these governance arrangements actually work. I mean, you've used the example of Hong Kong, but that was effectively a British colony, and so there was a sense of British ownership or responsibility for what happened there. And in your scenario with Michael Bloomberg, if Honduras sinks into conflict, who's responsible? I mean, if it's attacked, is it some, you know, NATO Charter 5 issue if there's a Michael Bloomberg and the U.S. is on board? Militarily, who responds? I mean, I -- it's not going to be the Swiss. Is it -- is it going to be the Danes or somebody else?

And what happens if your Michael Bloomberg viceroy, you know, becomes sort of a despotic character who's doing untoward things in the city-state? Who's then responsible for overseeing him and removing him if he becomes problematic?

ROMER: Yeah. So on the first question, we often use words to invoke a feeling without necessarily focusing on what the words mean.

So think about the case of those 75,000 Hondurans each year who migrate to the United States at great risk to themselves, at huge financial cost, serious risk to their personal security and a very unattractive legal status when they get to the United States.

Is that postmodern colonialism, that they want to come live under the kinds of conditions that we want our children to have available for where they live and work? You can call it postmodern colonialism, but I don't see what it buys you. If people want something, I think we should give them the choice and let them decide for themselves what's right for them. And the tragedy right now is there's no place nearby that people can go without risk of being kidnapped, take their families, live legally, know that their kids will get an education. And it can't possibly be a bad thing to create some more choices like that, given the ones that Hondurans are already making.

Now, the other practical question you alluded to is who makes sure that Michael Bloomberg doesn't misbehave? That's built into the basic law, so not the constitutional amendment, but the basic law, which we anticipate will have a structure where there are representatives on some kind of a board -- like somebody nominated by the Swiss, somebody nominated by Canada, somebody by Denmark, who appoint the mayor, hold the mayor accountable, make a decision about reappointment. So it's, in many ways, it's just like the kind of arrangement we have with Ben Bernanke. He's got a lot of freedom to do stuff on a day-to-day basis, but there's a clear mandate for what he's supposed to accomplish and a clear provision for reappointment for selecting a successor.

So this is not at all like suggestions that we revert to some form of authoritarian rule. This is absolutely built in from the beginning, democratic accountability for this chief executive. But that doesn't have to mean democratic accountability in the sense of a locally run election. There can be other representatives, other democracies that hold an executive like this accountable. And as I said before, if there is a real threat, I think it's much more likely to be the kind of threat that, say, drug gangs present in Mexico right now or that Chavez presents in other countries, which, to a large extent, are just open intimidation through threats of physical violence, which you have to prevent by a security force that makes sure that that's never a successful strategy.

The other thing which we're seeing just pervasively is manipulation of the political system by the drug gangs, by Chavez and the like. And so part of what might make people more comfortable to go to someplace where the mayor was appointed by the Danes and the Canadians is they know that it's not going to be subverted by enough money from the drug gangs or the Chavez types.

So I think it's likely to be a very attractive arrangement in a part of the world where things are very, very unstable right now.

MALLABY: Okay. We've got time for one more question. Before we take it, I want to remind people that this is on the record. And we'll go over here for the last question. Wait for the microphone, please.

QUESTIONER: I hope this is fair, I'm related to the speaker.

MALLABY: Yes, yes. Perhaps you could tell everybody who you are. (Scattered laughter.)

QUESTIONER: As an observer of the American political scene, as a governor and as the chairman of the national Democratic Party, I am very interested in this fact that this out-of-the-box idea is being pushed by Honduras that changed its constitution. It didn't talk about it; it did it last week. That is in an atmosphere in which this nation, for years, has been trying to do its own form of intervention and economic development, which has a pretty bad record.

It would seem there is a real, should be a real audience in this country for another way at least to contrast.

So my question is -- because all new ideas that come to this city are given a pretty hard time -- the question is, is our posture to be, sit back and let's see what happens? We'll watch them, you know, go their way and join five years from now? Or do we have an obligation or an opportunity as a group of organizations in a nation that care about change to create a more viable alternative? In short, in one sentence, I'm fascinated that the driving force this particular week comes from Honduras as contrasted to the United States.

MALLABY: Well, the question from Governor Romer to Professor Romer was actually maybe a question for the rest of the people in the room, but if you want to take a last minute or so to just wrap it up, that would be great.

ROMER: Well, let me just say one fact here, which is that this idea started first in Honduras. People there were talking about the idea of could they persuade a nation to establish an embassy in Honduras where the grounds of the embassy would be several hundred square kilometers and they were hoping that somehow the international law of embassies would mean that they would have extraterritoriality and could set up a new city there in Honduras.

So that was the discussion that people there in Honduras were having when they heard about the more abstract discussions I'd been having about charter cities. So they came to me and they've taken some things I've suggested and they've, you know, modified, rejected other things that I've suggested. But this is something which is coming from the people of Honduras who really desperately perceive the need to vote, initiate growth, but make sure that growth is inclusive and get past histories -- a history of animosity and fear in their country, which has just been holding them back ever since the first European contact.

So I think -- my view is that if I can answer your question, I think we should be ready to be as helpful as we can. The world doesn't have enough experiments and enough places where a country says, we're willing to try something different. So I hope I've persuaded at least a few of you to keep an open mind about being receptive to what they're doing and maybe even being helpful.

UNAUTHORIZED REPRODUCTION, REDISTRIBUTION OR RETRANSMISSION CONSTITUTES A MISAPPROPRIATION UNDER APPLICABLE UNFAIR COMPETITION LAW, AND FEDERAL NEWS SERVICE, INC. RESERVES THE RIGHT TO PURSUE ALL REMEDIES AVAILABLE TO IT IN RESPECT TO SUCH MISAPPROPRIATION.

FEDERAL NEWS SERVICE, INC. IS A PRIVATE FIRM AND IS NOT AFFILIATED WITH THE FEDERAL GOVERNMENT. NO COPYRIGHT IS CLAIMED AS TO ANY PART OF THE ORIGINAL WORK PREPARED BY A UNITED STATES GOVERNMENT OFFICER OR EMPLOYEE AS PART OF THAT PERSON'S OFFICIAL DUTIES.

FOR INFORMATION ON SUBSCRIBING TO FNS, PLEASE CALL 202-347-1400 OR E-MAIL INFO@FEDNEWS.COM.

THIS IS A RUSH TRANSCRIPT.

-------------------------

SEBASTIAN MALLABY: (In progress.) Also importantly, please turn off those things that go beep and vibrate and so forth, because it messes up the sound system.

Here, we're here with Paul Romer, who is the Henry Kaufman visiting professor at the New York Stern School, but more deeply and broadly than that, has a very varied and interesting trajectory, starting as an economic theorist, mostly at Stanford; known in the 1990s as the father of new growth theory, which stresses that the traditional inputs into people's growth models -- labor, capital and so forth -- were inadequate, and that they left out the crucial role of ideas, and that once you started to understand that, it had big implications for how you could kick-start or accelerate growth, both in rich countries like the U.S., but also, importantly, in poor countries.

After that, Paul set up a -- an education software company, which he ultimately sold. He tells me that he didn't sell it at such a price that he's rich by Silicon Valley standards, but nonetheless it was very successful.

And then in the last two or three years, he's devoted most of his energy to something called the charter cities movement, which is what we're going to discuss.

So let's start there, Paul. I mean, tell us, you know, what is the charter cities idea, and what drew you to devote all your energy to it?

PAUL ROMER: Yeah. Let me actually take it in reverse order and say where this idea first came from. When I was in Chicago, when I was a professor there before I went to Stanford, there was a woman who worked for my wife and me. My wife was in a residency program, so this woman helped cook and clean in our house. And she lived in the Cabrini-Green housing project in Chicago, which as many of you know is one of the most desperate failures in our public housing system. And the question that struck me, when I saw her and these two young children she was raising, is why she didn't have a chance to move to a city which could offer simple things like relatively low-cost housing and low crime. She simply didn't have that option in the United States. And I started to ask why couldn't it be possible to create entirely new cities that could offer options like that for someone like her.

So that idea has stayed with me now for 25 years. And the application now is in -- is in the developing world, where there are hundreds of millions -- really, billions of people who are in the same position that she's in. And the charter cities movement is about taking seriously the idea that we could build entirely new cities that could present a different range of options to the least-advantaged people on Earth.

MALLABY: And this links back to your theoretical work on what drives growth, because as you explained, ideas are not merely new technologies. They're also, very importantly, rules, right?

ROMER: Yeah. Yeah. There's a -- there's a saying we use to explain that -- what's unique about ideas, their shareability. And I'm sure you all know it, but if you give someone a fish, you feed them for a day, but if you teach someone to fish -- you destroy another aquatic ecosystem. (Laughter.)

And what that suggests is, is that new ideas like trawlers and nets are things that we can share and use all over the world. But if we don't have advances in our rules, say that limit the catch in a fishery along with technological advances, those new technologies could do more harm than good.

In the developing-world context, the problem is often that the rules prevent valuable technologies. One I talk about a lot is just electrical light in the house, a hundred-year-old technology that still isn't available to many poor people all over the world. There -- that technology is not being made available to them because of the local rules that prevent it. And so I switched from thinking about how can we invent new improvements beyond electrical light, to thinking about how can we have improvements, innovation, diffusion of better rules alongside of innovation and diffusion of better technologies.

MALLABY: So in other words, the very fact that there are a lot of technologies that have existed for a long time, but yet are not actually adopted, suggests that it's the conditions for adoption that might matter more than the technologies themselves.

ROMER: Yeah, absolutely. And it's easy to think, oh, well, the poor people can't afford new technologies. But if you look at something like water, this ancient technology for delivering municipal water through pipes and taps, that technology's cheaper than the ones that poor people pay to get their water delivered to them in most slums around the world. So it's not that people -- poor people can't afford to pay for some of these modern technologies, but something deep in the system is preventing the development of something like a municipal water system that provides lower-cost, safer water.

MALLABY: Safer than having the water brought to you in some plastic container that --

ROMER: Yeah, plastic jug from a truck, from an unknown source.

MALLABY: Right. Right. Right. I mean, you use a very arresting image to get this point across sometimes, which is this photograph of kids doing their homework in an African city under a street light. And the kids probably have cell phones?

ROMER: Yeah.

MALLABY: Which is a newer technology than electric lighting. But they obviously do not have electric lighting at home. Otherwise, they would be doing their homework at home.

ROMER: Right.

MALLABY: So I guess this leads to the question, you know, people have observed for maybe 20 years, at the World Bank and other development organizations, that governance is very important, that rules matter, that institutions matter.

ROMER: Mm-hmm.

MALLABY: The question is: How do you actually encourage countries to improve their governance? I mean, and that's where you have some ideas as well.

ROMER: Yeah. Sure. So one suggestion I'm making at every opportunity is, let's take that word "institutions" and just stop using it. It's just too confusing and it's too vague, so think about rules. And when you -- every time you think about rules, think about laws and social norms about what's right and wrong. So the challenge is: How can we take an existing set of laws and norms, and change them to get to a new set of laws and norms?

I think one of the problems in the debate is we focused too much on the laws; we didn't think enough about the importance of norms. I think we also tended to assume that when there were bad rules in place, we wanted to look for a bad person to blame; like who's the bad person in charge? Who's the elite that's stifling opportunity for others? Let's find a bad person to blame, and then somehow change that person, and then we'll get to good rules. And I think that is just a dead end. It just doesn't correspond to the facts.

What we see are collections of people who all behave according to a given set of rules, and it's simply not possible, even for the leaders, to unilaterally change those -- change those rules in context. So we've got to figure out why is it hard for all these people, who can see that there are better rules, to not be able to change their rules, and then historically, what has actually worked to allow a change in rules when the -- kind of the frontal assault often fails.

MALLABY: So what's the answer?

ROMER: So the answer, I think, is this notion of a startup, where some group of people who are willing to try something differently say: Let us go off by ourselves. We'll develop both different laws, perhaps, but importantly, different norms about right and wrong. We'll reinforce that in our little culture that operates separately. And then, if these turn out to be a success and be better, we'll not only demonstrate to others that there's something which is better, but we'll also provide a mechanism where people can move from the equilibrium where one set of rules and norms prevails to this other one.

They can get socialized into those new rules, especially the norms, by exposure to them. And in a voluntary way without any coercion, you can move from one set of arrangements to another set of arrangements that are radically different, but at each step along the way, nobody was forced to change what they were doing here and adopt immediately what's working elsewhere.

MALLABY: So an analogy here would be between charter cities that you advocate in developing countries and charter schools in the United States. So one approach to school reform is to try to, you know, persuade people on the board of education to vote for a different -- choose a different superintendent and have, you know, reform from within.

ROMER: Yeah.

MALLABY: And then the alternative is to say that's really difficult because the existing school system sort of has a set of norms that are quite difficult to shift. So let's try reform from without through charter schools that sort of start out with new sets of norms.

ROMER: Yeah. So if you think about something like a KIPP school, it would be very hard to get a consensus with any existing school to shift this very different style of instruction and interaction with students at a KIPP school. But if you start a brand new one and say this is how it'll be run, students and teachers will go and try it out. But the charter schools lesson also has a caution for us, which is, I think, that if you don't operate at the right scale, you're not going to succeed.

I think that for dramatic change in education, you need to think at the level of a bigger system that probably is the scale of a city. So you need to change the whole governance structure, schooling in the city and how you measure performance and how you train people there.

So if you create these start-ups in a way which is too small and they're too dependent on the rest of the environment within which they work, they may be doomed to failure. And we've seen many countries around the world try to use this entity that they call a special economic zone, where they liberalize or change the rules in those zones, give firms the option to opt in there, so it has the elements I was describing before. But they're not self-sufficient; they're too dependent on the surrounding systems. And so they can't by themselves get the kind of success you could get if you took a city, which I think is, in many cases, the right unit to think about for doing things in a self-contained, comprehensive way.

MALLABY: And -- so another analogy is with the way that change takes place within business, and, you know, when IBM builds up a business, which is very, very good at selling big mainframes to corporate customers, and then along comes the personal computer and you've got to suddenly sell to individuals. It turned out that they had a lot of difficulty changing their business culture to be nimble enough to sell to individuals. And so another company sprung up from somewhere else, Dell or whatever, right?

So is that another good analogy with what you're --

ROMER: Yeah. There's -- I think there's a very fruitful analogy between cities and corporations, and they operate in an environment where they're competing with each other and start-ups can sometimes do things that the existing organizations can't do. And it helps, I think, guide certain intuitions that come to mind when we think about political change.

One of the very common reactions I get about a charter city is if you start at a brand new city with a particular set of rules, it might not succeed, it might not be a success like Hong Kong. To which my answer is, that's exactly right and we should start a number of them, just like we should start many small start-up firms. So the transition to the, you know, the computer on your desk and then the computer in your pocket, we think can remember the ones that succeeded; we don't remember all of the dozens or more that tried and failed. But the point at the level of the industry, and it will transfer to the world as a whole, is the cost of the failures is really extremely low. And the benefits of the successes are enormously important.

So we should be as open to the idea of brand new cities that start out and try and do things differently as we are to the options for brand new firms. And the one other thing that makes this so easy to do right now is that we live in a time where the world is desperately short on cities. You know, 3 billion people live in cities right now. In the next 30 years, 50 years, another 3 billion people will move into cities.

So we need to do urbanization on a scale that humans have never done before, more than we've done in all of history. And then the other interesting thing about this time is that once we've done it in this century, things will pretty much be over; we'll never again have the chance to influence the worldwide system of cities because we're going to reach a maximum population on Earth this century. We're going to reach probably a stable percentage of the population that lives in cities.

So one way or another, we're going to establish the system of cities for the whole world this century. And why not use it as a chance to try some things differently, do some things better rather than just grow by accretion all the -- all the many -- in many cases, badly run cities that exist right now.

MALLABY: I want to make sure that people understand how differently you're proposing, because you're saying not merely that there should be new start-up charter cities. You're saying that the people who run these cities ought to be outsiders, people from outside the country precisely to try to escape the existing rule set. You need, for example, if it's going to be Nigeria, that a consortium of European governments show up and start to run a new city, which may teach Lagos what it's done wrong.

ROMER: Yeah. This approach is one that could be used in many different places. So we'll talk -- come in a second and about Honduras where what you're describing is, I think, exactly what people in Honduras are expecting, that other governments will come in and help set up the governance for the new city they want to establish in Honduras. So think of it as a partnership between Honduras and a number of other governments who can bring both institutional credibility and administrative experience on basic things like the administration of law.

MALLABY: And we should just say for those who don't read the Central American newspapers every day that Honduras passed a constitutional amendment last week, which opens the way towards creating a charter city in Honduras and inviting foreigners to come in and administer.

ROMER: So we'll come back and talk about the specifics there in a moment. But I wanted to say that even though that might be the right model for Honduras, think about India right now. India might have a model where they create, entirely through their internal resources, brand new empty spaces where a new administration could be put in place and a whole new city could grow up.

So this idea of chartering an entirely new city could be something that's done entirely within a country, as China did with -- (word inaudible) -- next to Hong Kong, but in much of the developing world you have countries that are very small, that don't have the kinds of central resources that a country like India might have or countries like Honduras or many countries in sub-Saharan Africa. And there are kind of strong partnerships that, I think, could be exploited, will be critical to success. And the historical model that's worth keeping in mind here is that of Hong Kong.

If you think of Hong Kong as a piece of China where the British said, we'll do a partnership with China; we'll come in, we'll set up a new city here, and we'll see which Chinese want to come and live under a very different set of rules; Hong Kong was an enormous success for the people who came there and ultimately a success that I claim was pivotal in helping encourage the transition to the rapid growth we've seen since the late 1970s in China.

So -- and to bring it back to Honduras, they're very open to creating a new city where foreign partners might have a very decisive say on what takes place there.

MALLABY: And, you know, if one was to ask them, why would you give up control over some chunk of coastal land so that foreigners can come and run it for you, why do you think their political system has just voted with, I think, almost a unanimous majority in the congress there to endorse this idea? It's just counterintuitive that a country would hand over a chunk of land to foreigners. Why do you think that's politically feasible?

ROMER: So -- yeah, let's be -- let's be frank. This is a country which had a change in the leadership of the country in the previous presidency which was very irregular. And some people called it a coup. Others have said, well, you know, this person was breaking the law. But they had -- they had a president that was forcibly removed from office, a transition president and now a new set of leaders who were elected in the regularly scheduled elections.

But they understand that if they go to a major sovereign wealth fund and somebody with experience in airports and say, come invest billions of dollars to build a major airport here in Honduras; they understand that on their own, they're not going to have the credibility to say we can promise you that you're going to be able to operate in a stable environment for the next 50 years and your rights as an investor will be protected and the health, safety, water, electricity, all these things will be managed relatively well; they simply don't have the credibility to make that commitment.

But they understand -- in a way, it's just like if I went to someone and said, look, I want to buy a house. I'm a good guy. Lend me -- you know, lend me a million dollars and trust me. It just -- it would never work. I mean, I give up sovereignty over my house to a judge, and I say to the judge, I'm promising to pay these guys back. If I don't pay them back, then you've got to come and take my house away from me. Giving away sovereignty over my house lets me do a deal with the mortgage leader I could never do on my own.

And the government in Honduras sees that they're in exactly that same position vis-a-vis this enormous supply of worldwide financial capital and technological experience that's extremely eager to find places to invest in things like infrastructure all over the world. But right now, they're kind of like me and the mortgage lender on our own. They just can't get the deal done unless there's somebody who could guarantee that both sides will stick to the terms of the deal.

MALLABY: Paul Collier at Oxford, and I guess to some extent Steve Krasner, your colleague at Stanford, have talked around this idea as well. So I think, you know, what they've observed is that a lack of credible rules has been a major impediment to development, to the attraction of inward investment, as you described.

And they've advocated various sort of steps short of what you're saying. In other words, you know, if you sign up for the World Trade Organization, you're effectively adopting binding commitments from outside to promise investors that you will have sensible rules on commerce. And that's a kind of commitment mechanism that proves you're serious. And you're saying, you know, let's go beyond that and just take a discrete chunk of territory and hand over the whole control for 50 years, for some long period.

ROMER: Yeah, yeah. I think it's -- given the importance of this problem and the importance of the gains from trade if we could facilitate these long-term investments from the rich and fast-growing countries, the gains are so large that we should be willing to experiment with a number of different mechanisms.

But I think if you look at attempts that have been made to do this and you look at what kinds of things went wrong, it gives you pause about the -- you know, sort of the simple solutions others have asked -- others have proposed.

Let me give you some examples. Singapore was very successful in developing a city within its boundaries, and they started to ask: How can we go out and develop other cities like this in other parts of the world?

So they developed an extremely large industrial park, really a small-scale city on Batam Island in Indonesia. They also tried to develop a very large site outside of Shanghai in China. And in each case, it wasn't that some government came in and just expropriated the physical capital that they had put in place, but there were a series of subtle changes -- it's what I call death by a thousand cuts -- which took opportunities, which were very -- well, in Indonesia, it was very successful for a while, and then the government changed certain parts of labor regulation and just destroyed the viability of these investments.

In China, it was the opposite case, where they had put in all the infrastructure in the ground and then no businesses were willing to come because the local governments were sending all these subtle signals about things that -- things could go wrong in this zone if foreigners came and invested in the Singapore zone instead of one the city wanted to develop.

And I'm told there were stories like, you'd show up at this huge industrial park that Singapore was developing, and there'd be a big pile of dirt on the road blocking entrance. And you'd call the local government trying to figure out, who do we get to move the pile of dirt, and nobody knew. And Lee Kuan Yew would personally call Deng Xiaoping and say, you know, who could -- who do I got to talk to to move that pile of dirt? And, you know, Deng Xiaoping doesn't have any clue.

So the kinds of ex -- post-opportunistic behavior you can get subjected to here is subtle and has a lot to do not just with the law, which is important, to be sure, but also things like just local administration, the competence of the civil service, the transparency of the civil service.

And so bringing in a country that has experience with transparent, open, visible administration, regulation and legislation can be a way to quickly to the equilibrium that will really provide confidence for the investors.

MALLABY: So, I mean, just to sum up here, so supposing we take Honduras as an example, and the argument is that, you know, for umpteen years, World Bank missions have visited Honduras, and they've said, you know, you've got a governance problem; you need to do various kinds of reforms to fix your rules so that you get a better growth. And the problem is the entrenched elites or the system in general is too ossified -- it's like IBM setting its mainframes -- and it cannot make this switch to a better equilibrium of better rules.

So now you say, okay --

ROMER: Although, let me make one slight nuance there. Think of this partly as two sides, both of which are very afraid of being taken advantage by the other side. So you've got people with historical claims to large amounts of land who feel very threatened by peasants who are talking about, you know, like land invasions and seizures of land.

On the other hand, you have peasants and low-wage workers who feel like the landowners have taken advantage of special access through the legal system to get a position that is unjustified and they may do even more. So it's not just ossification, but a real fear on either side that if you created some government entity with some power, one or the other side is going to grab ahold of it and use it to disadvantage the other.

MALLABY: Right. But so for complex political economy reasons, it's tough to get the reform that would really stimulate growth. The creation of the better rules is difficult. And we've tried this for a long time. So now let's think outside the box, and instead of trying to get the Honduran polity to reform itself, let's have this charter city -- like a charter school, let's start off a rival, where you have on this coastal piece of land a consortium, and it's the Swiss government, and in alliance with the Dutch and Danish governments. And they come in together. They've got extremely good rules in their own countries. They understand transparency. They understand rule of law. They have fantastic rules in this new city. And now they're going to attract all kinds of investment.

But isn't the threat of the pile of debt outside the charter city, put there by the jealous mayor from the local Honduran city, isn't that still there?

ROMER: So first, in the sequence here, part of how you get that transparency and you deal with a lot of the internal problems is that the Dutch and the Swiss -- and I forget who was your third, but they all agree to appoint an individual who is like the strong mayor, the executive, who has lots of discretionary powers, a very clear mandate, but whose job it is to get things done and hold that person accountable. So, strong executive leadership is very important.

MALLABY: Are you a candidate?

ROMER: No. (Chuckles.) Nobody who's been a university professor is a candidate for an executive position. (Laughter.)

MALLABY: Even the son of a former state governor?

ROMER: No. But then this gets back to my comment about why cities are important and things smaller than cities don't work. If this is on a coastal location, with its own port, with its own airport, its own power system, you could have literal walls to grow up on the border with the rest of Honduras, and this little entity becomes a self-sufficient city-state that thrives, just like Hong Kong thrived when mainland China was going through the cultural revolution.

And so in the conversations in Honduras, what the president and the members of Congress understand is they need to create an arrangement which is strong enough so that an investor says to him- or herself, my investment there will be viable, in the sense that my rights will be protected, but also in the sense that this will be thriving city, no matter what happens in Honduras. Even if there's, you know, revolution and violence and chaos in Honduras, this is big enough, this is self-contained, this will thrive no matter what.

MALLABY: I'm going to open up in a second to members. I'll just ask a final question, which is, what's the chances, realistically, that any developed country wants to take on this responsibility? Because you're sort of positing that they would actually resort to force of arms to defend this enclave if they needed to. Otherwise, it's not credible.

ROMER: Yeah. I think because of the recent experience in Afghanistan and Iraq, developed countries are going to be very hesitant about military commitments that in some sense they feel like they can't deliver on. But this is a commitment which is easy to deliver on, and I think it won't be hard to persuade people of this.

The line in the sand where someone has to invade across that line to cause a violation is extremely important because it so clearly signals the violation of the law, of international law. So think of the invasion by Iraq of Kuwait. It was not hard to mobilize people around the world, because this was wrong and had to be resisted, and it wasn't hard to push it back.

So that's not the problem. The problem that we face right now is when there's a group of people where the mission is to try and impose order on people where some of those people never asked for these outsiders to come in and use violence to impose order. And so I think it's a radically different situation where there are some people who have said, we want to live under these conditions where you help protect our borders; and, you know, we as citizens of the city will staff, you know, the national service entity that helps protect those things; we just need your commitment of, you know, freedom of navigation of the seas and, you know, a little bit of support.

That's a radically different situation than trying to go in and force a security or policing system on a population where some people might like it but the others become, you know, the rioters in Haiti right now or the National Liberation Movement that resists our presence in Iraq --

MALLABY: People in the city have voted with their feet. They've chosen to be there.

ROMER: Exactly. Everybody -- this is why Hong Kong had such a different experience than most other colonial ventures by the British; that everybody who lived there came there knowing full well what the arrangements would be, and those arrangements had a legitimacy, because of that choice to opt in, that anything that's imposed against people's will can never have.

MALLABY: Okay. Let's open it up. Who's got a question? Mitzi, here in the front. So please stand and state your name.

QUESTIONER: I'm Mitzi Wertheim with the Naval Postgraduate School. I started working for IBM the day they had their PC, and I watched this transformation. They transformed themselves by selling off things. And I'm -- a little unclear to me how cities can sell off things. That's just a question.

I also have a question about scale. And if you're going to create a new city, one of the things you have to have is an initial investment to build the infrastructure. And it's not clear to me where -- because that's substantial, whether it's electricity or whether it's sewage or whatever. Where does that money come from?

MALLABY: The financing question.

ROMER: Yep. And your questions are very closely linked. So let me take the financing one first.

There is an enormous amount of financial resources around the world that is very interested in infrastructure investment. They see this as exactly the kind of investment they want, guaranteed high returns for decades into the future. And these -- like these sovereign wealth funds and private investors have been totally burned by chasing the wave for the last -- you know, the last decade. So there's a huge amount of financial resources there.

What's missing is an environment where they can make those investments and be free of political risk. So the money is there if you can create the -- if you can create the political entity that would protect it.

QUESTIONER: (Off mic) -- right kind of people.

ROMER: Well, so then think about how this plays out. The airport, who would finance an airport? If this is going to be a city of 10 million people, lots of people would agree to finance the airport in exchange for the ability to just collect the landing fees there for both the passengers and the cargo that come through. Who would build the power system? You know, a firm that can charge for the electricity at the kind of rates we pay. Who would build the water system? So there's an awful lot of investment that could come in just based on self-interest on the part of the investors.

But what you need is a government which is strong enough to do two things: one, ensure that the initial deal that you make with the investors is respected from the side of the residents and the fee payers and the government; but on the other side, equally important, to guarantee that the firms stick to what they promise when they come in, because in many developing countries, they promise the world, they come in, they're the monopoly provider, and they say, oh, you know, I know we said X, but you're going to pay, you know, 2.5 times X or you don't have any water tomorrow.

So you need a strong government to protect, because both sides can behave badly in this kind of arrangement.

Now, one other thing. Who's going to pay for the schools here? Outside investors are not going to come in and pay for the schools. If you think about a tract of land, like a thousand square kilometers, which is what we're talking about here, it's about -- it's bigger than the size of either Singapore or Hong Kong; and you think about what that land would be worth -- it's worth nothing now, essentially -- you think about what that land would be worth if there were a city like Hong Kong or Singapore that was built there, it's just hundreds of billions of dollars in potential gain in the land itself, separate from what you have to pay for the buildings, the ports and power system and so forth.

There's a way to give the governing entity the returns on the value it's going to create in that land and use those returns as the way to pay for the basic services like policing and education, minimal health care, that make this a really attractive place to come to. So there's a way to do this that doesn't require any charity, that just harnesses mutually beneficial exchange, as long as we create an environment where people can safely contract with each other and do deals.

MALLABY: I should point out that in the U.S. foreign assistance context, we have two things going on right now: a big, announced desire to reform USAID and have new ideas, which is good for your idea; and a huge budgetary constraint, which might be good for your idea too.

Another question. In the middle.

QUESTIONER: Bob Winter with Arnold & Porter. What is the relationship between the new city-state and the rest of Honduras? And what happens if people join the city-state and then decide they really don't like it? And does the government of Honduras gain anything in the way of taxation, and therefore does it in fact have some control over the city-state?

And finally, trying to understand how this would operate in practicality, is the city-state run by an executive with, you know, a number of Danes and the like, or is it democratic? And if it's democratic, what do you do if you have the types of divisions within the city-state that you have in the rest of Honduras? And what leads you to believe that that will radically change?

ROMER: So let me work backwards again. All of this is under discussion right now. Very little of it is set in stone. To just be clear about the procedures here, there is a constitutional amendment which specifies what the Congress in Honduras can do in creating special development regions. And that specifies a few items about what are the powers of the Congress in that region as opposed to what would be the powers within the region. And the thrust of the amendment is to create enormous flexibility for some new government entity in that region to operate independently of the government.

So I guess I -- and now going back to your first part, things like fiscal transfers between the two have yet to be worked out. They haven't -- there's a second stage, where they have enabling legislation for a particular site, that will probably specify things like the involvement of partner governments in, say, appointing the strong mayor. And there may be some arrangements for fiscal transfers back and forth. They may decide that the smartest thing for Honduras and Hondurans is to not require any fiscal transfers at all and just make sure this thing right next to them is a big success.

Now, the Hondurans that I've spoken to think that in the early stages, it would be better -- it would be more attractive to Hondurans if, when they go to this city, they don't have a vote over who that executive in charge of the city is. So both some of the rich land-holding families who might want to invest there, some of the peasants who are landless and very frustrated about that, both sides may find it more attractive to go to a place where they know that the mayor was picked by the Danes and the Swiss rather than selected through some democratic process which could lead to one side taking advantage of the other side through, you know, patronage and militias and all the kinds of things we see around the world.

So the people in Honduras will make this call, but they may say not only will the foreign investors be happier if there aren't elections for the mayor in this place for many years; the firms who come in and hire people may also be more comfortable; the residents may actually be more comfortable, as well, going some place where they don't inject the kind of insecurity they've had to live with for so long in Honduras in this new place.

MALLABY: So when you go there, you don't get a vote, but by virtue of having gone there, you have already voted with your feet.

ROMER: Yeah. And by the way, I think it's absolutely essential for any country who sets up something like this, and for the world as a whole, to insist on not just a de-jure but a de-facto exit option for people, that no one should ever be trapped in one of these places. So they vote with their feet to come in, but they should always be free to leave if they don't like what they find.

MALLABY: Instead of the choice that cross-border migrants make all the time. They leave Honduras; they don't go to a charter city because there isn't one; they come to the United States, they don't get to vote here, at least at first, and they've chosen that. They've opted in.

ROMER: Yeah. I mean, if you think about the choice right now, a Honduran who comes to the United States typically has to leave his family behind -- suppose he's going to come work in construction. He leaves his family behind. He's going to live illegally in the United States, has no hope of voting for who the mayor is wherever he lives in the United States, and he's got a one-in-seven chance of being kidnapped and held for ransom by a Mexican gang on the transit to the United States.

So it's not very hard to imagine that a place close by, where he could take his family, where he could live as a permanent resident and have the same kind of economic opportunity he's seeking in the United States -- it's not very hard to imagine it being preferable to go to that place as opposed to come to the U.S. the way they do now.

MALLABY: Yeah, a question right here.

QUESTIONER: Hi. Rebecca Patterson, the Kauffman Foundation. I was just wondering if you could talk about the opting-in process, if there is some sort of selection criteria that you can -- you prevent spoilers.

ROMER: Again, this is something where the Hondurans will have to make their own choices. There are a few things that economic theory suggests going in. There's an issue like the one we face about health insurance and pre-existing conditions. You would be dangerous to start this by saying, well, for example, we guarantee that we're going to provide very large transfers for anybody who has some kind of disadvantage, because what happens is then you select a whole population that are committed to transfers.

In the same way, it'd be a disaster to say, "Well, we, the Honduran government, are going to give a whole bunch of tax concessions and payments for firms that will come and create jobs," because then what you do is attract a whole bunch of firms who are committed to, you know, bad equilibria with -- you know, with transfer payments and rent-seeking from the government. So you've got to set these rules up so that the people who come in come in because they want opportunity and they want to -- they want to work.

When you think about security issues, another question that I've raised is whether or not they want to think about, in some sense, the burden of proof when you ask someone to leave to be different from the burden of proof when you say, why not incarcerate someone for violating the law?

And I think they may well opt for the notion that, in principle, this city is available to anybody from Honduras, and they're committed to the idea this -- that this will be for the whole region as well, but that there may be conditions for coming to this place, like participation in something like national service, and conditions in terms of attachment to the workforce or going to school. And if you don't meet those kinds of conditions, you may just be asked to leave. You know, they might decide it's simply not an option in this city to be unemployed and not in school and just a source of -- a source of potential problems.

MALLABY: Another question. Fred here.

QUESTIONER: Thank you. Fred Tipson with the U.N. Development Program here in Washington. I wanted to ask you whether you'd looked at Jeff Sachs' Millennium Villages approach. But actually, I lived in Hong Kong twice, and I -- the analogy is fascinating, but it strikes me as --

ROMER: To what year? What years?

QUESTIONER: I was there from -- let's see: (1988/1998 ?) -- '91 and then '98 to 2001. So ten years apart.

ROMER: So ('88 ?) to '91.

QUESTIONER: Both before and after the transition.

ROMER: Okay. So you had -- okay. (Inaudible.)

QUESTIONER: Yeah.

But the question is really which analogy to Hong Kong's history is the relevant one. Because, as you know, in the beginning, the Scottish trading houses were the ones -- and the conditions for people were abysmal for, you know, most people in Hong Kong except for the British civil servants.

But then if you're talking about the take-off period, really so much depended on the influx of these powerful families from Shanghai who ran the businesses. And, of course, Hong Kong was a managed economy by the British -- still is a managed economy. And the notion of local people just had a whole -- you know, there -- a lot of people were in transition when I was there. People were getting their green cards to be able to have an exit strategy. It's a city that was -- that basically for the take-off period was building on the ability to manufacture in China, very cheap labor, almost forced labor conditions that entrepreneurs in China were able to take advantage of.

I just don't see these analogies coming true in Honduras. But I know you've probably thought deeply about the analogy and how it -- how maybe it does instruct how this can be done more effectively.

ROMER: Yeah. Yeah. I think the right -- the right picture to have in mind is Hong Kong in 1950, because then the prospect of the takeover by mainland China was very distant, so everybody was anticipating British administration. And this was a place where somebody from mainline China could come and get their first paying job, their first job with a wage -- and that's almost always in garment assembly -- I mean, we just see this over and over again all around the world -- then later into something like toys, light manufacturing. I mean, most of us in this room can remember what "Made in Hong Kong" meant when we were -- we were kids.

Those people didn't earn very much. They lived in tiny apartments. But that job and that apartment was a big step up for them from what they had on the mainland. And that job in particular, especially a formal-sector job with a firm that pays a wage and follows rules and enforces certain kinds of patterns of interaction with other people in the firm, there's a training -- an on-the-job education that comes from that kind of job, which is incredibly important for people who want to improve their quality of life.

So I think we have to be very open to the -- to the -- to the economic reality that the first jobs that most people will hold in, say, this new city in Honduras will be jobs that pay very little to be competitive with the worldwide garment industry and light manufacturing. They're going to live in tiny apartments, by our standards, fewer meters per person than we would -- we would ever want for ourselves.

But when they go there, they'll be telling us they're going there because that's better than the other options they've got, and because they know that there's a future like the future for all the -- virtually all the Chinese who went there in the 1950s who all rode the wave up into incredibly rapid increases in average income per capita.

MALLABY: But you could extend the point, I think, because if the analogy is Hong Kong in 1950, then by the time Fred moves to Hong Kong in the late '80s and there is -- then this interaction with Shenzhen and the building up of the hinterland and the interaction between the capitalists in Hong Kong and the sweatshops, and if that's -- that's also part of the vision here -- right? --

ROMER: Yup.

MALLABY: -- that the charter city ultimately does create spill-overs into the hinterland which are going to be good for the hinterland.

ROMER: Yeah. But, you know, and who knows how long it might take, but 20 years, 30 years, this charter city in Honduras might look like Hong Kong today or New York today, and there won't be any garment assembly or any toy manufacturing going on there, but it will now be a service and cultural and finance center which is serving other locations where people will still be going to get their first job in manufacturing. And those could be other locations adjacent to this location in Honduras, but it could be other locations that are just a plane ride or a ship ride away throughout Central America.

MALLABY: Right over here. You've been very patient. Thank you.

QUESTIONER: I'm Maureen Lewis from the World Bank. And I like out-of-the-box thinking, and I think this really falls under that category. And it's a very interesting idea.

I do have a couple of worries, having spent some time in Latin America.

One is that I gather there will be courts, but there don't need to be any jails, because you can send people away. I mean, it -- that's sort of a shorthand. But --

ROMER: My guess is there probably will be jails, too.

QUESTIONER: There will be jails. Okay. So you do have that cost.

But I think fundamentally I worry about two things.

One is the economic -- the economic viability of it depends on labor, basically, because you're going to bring in the capital, and you have the land, so that there's a little bit of a constraint there, given the problems that Honduras has had in the past in terms of a labor force that is not really prepared particularly well. And the garment -- the garment industry is very competitive worldwide. It's really hard to break into that, for many reasons that you can probably explain to me better than I can explain. That's one.

But the other issue that I do come back to is the political stability and what the guarantees are for investors against political upheaval. All it takes is a Chavez, and today you have this gleaming city, and tomorrow you're, you know, at the mercy of somebody who really is not going to abide by any of the rules that a previous government agreed to.

ROMER: So you have to -- you have to kind of scenario plan for something like this. So -- this won't happen, so I can use his name, but you know, Michael Bloomberg agrees that being president is really not very interesting, and Michael Bloomberg takes over and he's running this -- he's running this new city in Honduras. He gets to build a brand-new city from scratch.

And he's got commitments. He's appointed by the Swiss, the Canadians, the Norwegians. He's got investments that brings in the infrastructure and then the firms.

And remember, this isn't just a problem of getting access to cheap labor. The thing about cities is they create enormous value when they're well-run. So you're getting all of these gains from bringing millions of people in and letting them interact with each other really, really intensely. So that's the value he's creating.

And then Chavez takes over the rest of Honduras. You know, Bloomberg goes: Fine. You know, cross the border -- you better be shooting when you cross the border, because you can't come in. And he just -- he keeps running his city; goods are coming in and out of the port; planes are taking off, flying in and out, just like Hong Kong during the Cultural Revolution. You know, what's the problem?

Chavez says: Well, we -- you know, we tore up the old constitution. This is our land.

Bloomberg says: Okay. Well, what are you going to do? Drive across the border shooting?

MALLABY: I think it's worth sort of underlining a point you, I think, were getting at earlier --

ROMER: Yeah.

MALLABY: -- that there's a hierarchy of international commitments, some of which are violated very, very easily --

ROMER: Yup.

MALLABY: -- and don't have much credibility, and others to do with clearly demarcated borders. In fact, the record is that when people violate those and they come across shooting --

ROMER: Yeah.

MALLABY: -- then there is an international response.

ROMER: Yeah. I mean, the reason I'm sort of being provocative about this is that people don't -- I mean, almost nobody, except for, you know, Saddam Hussein in Kuwait, has tried this ploy recently. The only other one was the Argentines trying to take back the Falkland Islands.

So it's really implausible that any -- you know, that any leader in any surrounding region would try and mount a military invasion, because even countries who hadn't, say, signed on as, you know, people who help appoint the mayor are going to react to such a -- you know, such a brazen attempt at, you know, violating, you know, the sovereignty or the integrity of a political jurisdiction.

So I think what you should worry about are not the invasions but the subtle -- kind of the potential for death by a thousand cuts. And so, you know, this is exactly what people are talking about in Honduras right now with the constitutional amendment. Constitution reserves for the government of Honduras control of the air -- the air rights over this -- over this area. That can't be delegated under the constitution without more changes than they wanted to make to the -- to Bloomberg. So Bloomberg can't control air traffic over his city.

But Bloomberg can go out and sign treaties with many nations around the world that guarantee free passage of air traffic, just like the treaties we use that guarantee innocent passage through maritime waters. And then if the Chavez-like leader wants to say, well, our air traffic guys aren't letting any planes take off in and out of your -- you know, in and out of your city, well, now he's got a beef with nations all over the world because he's violating treaty commitments to all of them, not just an internal dispute with this -- with the city. And then -- you know, then what's to stop Bloomberg from just saying, you know, we've got our own air traffic controllers now; we direct the planes when to take off?

So you can -- you can scenario plan fairly specific kinds of circumstances here, but the overriding thing you can come back to is that there's no economic reason why a city like this couldn't be set so that it can be totally viable regardless of what happens in the rest of Honduras. And so if you plan for what would happen if the rest of Honduras plunges into chaos, then you can be confident that actually it'll never happen. Yeah.

MALLABY: (Inaudible) -- in the back.

QUESTIONER: Hi. Amanda Sloat. I'm intrigued by the idea, but it seems if you take a more cynical approach, it smacks a bit of postmodern colonialism, that you have an underdeveloped country and so you have a bunch of wealthy Western nations with spare capital looking for an easy place to make money and have the cheap labor and come in and effectively build a town off the back of a poorer country. So I'd be curious to hear your response to that

And second, how some of these governance arrangements actually work. I mean, you've used the example of Hong Kong, but that was effectively a British colony, and so there was a sense of British ownership or responsibility for what happened there. And in your scenario with Michael Bloomberg, if Honduras sinks into conflict, who's responsible? I mean, if it's attacked, is it some, you know, NATO Charter 5 issue if there's a Michael Bloomberg and the U.S. is on board? Militarily, who responds? I mean, I -- it's not going to be the Swiss. Is it -- is it going to be the Danes or somebody else?

And what happens if your Michael Bloomberg viceroy, you know, becomes sort of a despotic character who's doing untoward things in the city-state? Who's then responsible for overseeing him and removing him if he becomes problematic?

ROMER: Yeah. So on the first question, we often use words to invoke a feeling without necessarily focusing on what the words mean.

So think about the case of those 75,000 Hondurans each year who migrate to the United States at great risk to themselves, at huge financial cost, serious risk to their personal security and a very unattractive legal status when they get to the United States.

Is that postmodern colonialism, that they want to come live under the kinds of conditions that we want our children to have available for where they live and work? You can call it postmodern colonialism, but I don't see what it buys you. If people want something, I think we should give them the choice and let them decide for themselves what's right for them. And the tragedy right now is there's no place nearby that people can go without risk of being kidnapped, take their families, live legally, know that their kids will get an education. And it can't possibly be a bad thing to create some more choices like that, given the ones that Hondurans are already making.

Now, the other practical question you alluded to is who makes sure that Michael Bloomberg doesn't misbehave? That's built into the basic law, so not the constitutional amendment, but the basic law, which we anticipate will have a structure where there are representatives on some kind of a board -- like somebody nominated by the Swiss, somebody nominated by Canada, somebody by Denmark, who appoint the mayor, hold the mayor accountable, make a decision about reappointment. So it's, in many ways, it's just like the kind of arrangement we have with Ben Bernanke. He's got a lot of freedom to do stuff on a day-to-day basis, but there's a clear mandate for what he's supposed to accomplish and a clear provision for reappointment for selecting a successor.

So this is not at all like suggestions that we revert to some form of authoritarian rule. This is absolutely built in from the beginning, democratic accountability for this chief executive. But that doesn't have to mean democratic accountability in the sense of a locally run election. There can be other representatives, other democracies that hold an executive like this accountable. And as I said before, if there is a real threat, I think it's much more likely to be the kind of threat that, say, drug gangs present in Mexico right now or that Chavez presents in other countries, which, to a large extent, are just open intimidation through threats of physical violence, which you have to prevent by a security force that makes sure that that's never a successful strategy.

The other thing which we're seeing just pervasively is manipulation of the political system by the drug gangs, by Chavez and the like. And so part of what might make people more comfortable to go to someplace where the mayor was appointed by the Danes and the Canadians is they know that it's not going to be subverted by enough money from the drug gangs or the Chavez types.

So I think it's likely to be a very attractive arrangement in a part of the world where things are very, very unstable right now.

MALLABY: Okay. We've got time for one more question. Before we take it, I want to remind people that this is on the record. And we'll go over here for the last question. Wait for the microphone, please.

QUESTIONER: I hope this is fair, I'm related to the speaker.

MALLABY: Yes, yes. Perhaps you could tell everybody who you are. (Scattered laughter.)

QUESTIONER: As an observer of the American political scene, as a governor and as the chairman of the national Democratic Party, I am very interested in this fact that this out-of-the-box idea is being pushed by Honduras that changed its constitution. It didn't talk about it; it did it last week. That is in an atmosphere in which this nation, for years, has been trying to do its own form of intervention and economic development, which has a pretty bad record.

It would seem there is a real, should be a real audience in this country for another way at least to contrast.

So my question is -- because all new ideas that come to this city are given a pretty hard time -- the question is, is our posture to be, sit back and let's see what happens? We'll watch them, you know, go their way and join five years from now? Or do we have an obligation or an opportunity as a group of organizations in a nation that care about change to create a more viable alternative? In short, in one sentence, I'm fascinated that the driving force this particular week comes from Honduras as contrasted to the United States.

MALLABY: Well, the question from Governor Romer to Professor Romer was actually maybe a question for the rest of the people in the room, but if you want to take a last minute or so to just wrap it up, that would be great.

ROMER: Well, let me just say one fact here, which is that this idea started first in Honduras. People there were talking about the idea of could they persuade a nation to establish an embassy in Honduras where the grounds of the embassy would be several hundred square kilometers and they were hoping that somehow the international law of embassies would mean that they would have extraterritoriality and could set up a new city there in Honduras.

So that was the discussion that people there in Honduras were having when they heard about the more abstract discussions I'd been having about charter cities. So they came to me and they've taken some things I've suggested and they've, you know, modified, rejected other things that I've suggested. But this is something which is coming from the people of Honduras who really desperately perceive the need to vote, initiate growth, but make sure that growth is inclusive and get past histories -- a history of animosity and fear in their country, which has just been holding them back ever since the first European contact.

So I think -- my view is that if I can answer your question, I think we should be ready to be as helpful as we can. The world doesn't have enough experiments and enough places where a country says, we're willing to try something different. So I hope I've persuaded at least a few of you to keep an open mind about being receptive to what they're doing and maybe even being helpful.

UNAUTHORIZED REPRODUCTION, REDISTRIBUTION OR RETRANSMISSION CONSTITUTES A MISAPPROPRIATION UNDER APPLICABLE UNFAIR COMPETITION LAW, AND FEDERAL NEWS SERVICE, INC. RESERVES THE RIGHT TO PURSUE ALL REMEDIES AVAILABLE TO IT IN RESPECT TO SUCH MISAPPROPRIATION.

FEDERAL NEWS SERVICE, INC. IS A PRIVATE FIRM AND IS NOT AFFILIATED WITH THE FEDERAL GOVERNMENT. NO COPYRIGHT IS CLAIMED AS TO ANY PART OF THE ORIGINAL WORK PREPARED BY A UNITED STATES GOVERNMENT OFFICER OR EMPLOYEE AS PART OF THAT PERSON'S OFFICIAL DUTIES.

FOR INFORMATION ON SUBSCRIBING TO FNS, PLEASE CALL 202-347-1400 OR E-MAIL INFO@FEDNEWS.COM.

THIS IS A RUSH TRANSCRIPT.

-------------------------

SEBASTIAN MALLABY: (In progress.) Also importantly, please turn off those things that go beep and vibrate and so forth, because it messes up the sound system.

Here, we're here with Paul Romer, who is the Henry Kaufman visiting professor at the New York Stern School, but more deeply and broadly than that, has a very varied and interesting trajectory, starting as an economic theorist, mostly at Stanford; known in the 1990s as the father of new growth theory, which stresses that the traditional inputs into people's growth models -- labor, capital and so forth -- were inadequate, and that they left out the crucial role of ideas, and that once you started to understand that, it had big implications for how you could kick-start or accelerate growth, both in rich countries like the U.S., but also, importantly, in poor countries.

After that, Paul set up a -- an education software company, which he ultimately sold. He tells me that he didn't sell it at such a price that he's rich by Silicon Valley standards, but nonetheless it was very successful.

And then in the last two or three years, he's devoted most of his energy to something called the charter cities movement, which is what we're going to discuss.

So let's start there, Paul. I mean, tell us, you know, what is the charter cities idea, and what drew you to devote all your energy to it?

PAUL ROMER: Yeah. Let me actually take it in reverse order and say where this idea first came from. When I was in Chicago, when I was a professor there before I went to Stanford, there was a woman who worked for my wife and me. My wife was in a residency program, so this woman helped cook and clean in our house. And she lived in the Cabrini-Green housing project in Chicago, which as many of you know is one of the most desperate failures in our public housing system. And the question that struck me, when I saw her and these two young children she was raising, is why she didn't have a chance to move to a city which could offer simple things like relatively low-cost housing and low crime. She simply didn't have that option in the United States. And I started to ask why couldn't it be possible to create entirely new cities that could offer options like that for someone like her.

So that idea has stayed with me now for 25 years. And the application now is in -- is in the developing world, where there are hundreds of millions -- really, billions of people who are in the same position that she's in. And the charter cities movement is about taking seriously the idea that we could build entirely new cities that could present a different range of options to the least-advantaged people on Earth.

MALLABY: And this links back to your theoretical work on what drives growth, because as you explained, ideas are not merely new technologies. They're also, very importantly, rules, right?

ROMER: Yeah. Yeah. There's a -- there's a saying we use to explain that -- what's unique about ideas, their shareability. And I'm sure you all know it, but if you give someone a fish, you feed them for a day, but if you teach someone to fish -- you destroy another aquatic ecosystem. (Laughter.)

And what that suggests is, is that new ideas like trawlers and nets are things that we can share and use all over the world. But if we don't have advances in our rules, say that limit the catch in a fishery along with technological advances, those new technologies could do more harm than good.

In the developing-world context, the problem is often that the rules prevent valuable technologies. One I talk about a lot is just electrical light in the house, a hundred-year-old technology that still isn't available to many poor people all over the world. There -- that technology is not being made available to them because of the local rules that prevent it. And so I switched from thinking about how can we invent new improvements beyond electrical light, to thinking about how can we have improvements, innovation, diffusion of better rules alongside of innovation and diffusion of better technologies.

MALLABY: So in other words, the very fact that there are a lot of technologies that have existed for a long time, but yet are not actually adopted, suggests that it's the conditions for adoption that might matter more than the technologies themselves.

ROMER: Yeah, absolutely. And it's easy to think, oh, well, the poor people can't afford new technologies. But if you look at something like water, this ancient technology for delivering municipal water through pipes and taps, that technology's cheaper than the ones that poor people pay to get their water delivered to them in most slums around the world. So it's not that people -- poor people can't afford to pay for some of these modern technologies, but something deep in the system is preventing the development of something like a municipal water system that provides lower-cost, safer water.

MALLABY: Safer than having the water brought to you in some plastic container that --

ROMER: Yeah, plastic jug from a truck, from an unknown source.

MALLABY: Right. Right. Right. I mean, you use a very arresting image to get this point across sometimes, which is this photograph of kids doing their homework in an African city under a street light. And the kids probably have cell phones?

ROMER: Yeah.

MALLABY: Which is a newer technology than electric lighting. But they obviously do not have electric lighting at home. Otherwise, they would be doing their homework at home.

ROMER: Right.

MALLABY: So I guess this leads to the question, you know, people have observed for maybe 20 years, at the World Bank and other development organizations, that governance is very important, that rules matter, that institutions matter.

ROMER: Mm-hmm.

MALLABY: The question is: How do you actually encourage countries to improve their governance? I mean, and that's where you have some ideas as well.

ROMER: Yeah. Sure. So one suggestion I'm making at every opportunity is, let's take that word "institutions" and just stop using it. It's just too confusing and it's too vague, so think about rules. And when you -- every time you think about rules, think about laws and social norms about what's right and wrong. So the challenge is: How can we take an existing set of laws and norms, and change them to get to a new set of laws and norms?

I think one of the problems in the debate is we focused too much on the laws; we didn't think enough about the importance of norms. I think we also tended to assume that when there were bad rules in place, we wanted to look for a bad person to blame; like who's the bad person in charge? Who's the elite that's stifling opportunity for others? Let's find a bad person to blame, and then somehow change that person, and then we'll get to good rules. And I think that is just a dead end. It just doesn't correspond to the facts.

What we see are collections of people who all behave according to a given set of rules, and it's simply not possible, even for the leaders, to unilaterally change those -- change those rules in context. So we've got to figure out why is it hard for all these people, who can see that there are better rules, to not be able to change their rules, and then historically, what has actually worked to allow a change in rules when the -- kind of the frontal assault often fails.

MALLABY: So what's the answer?

ROMER: So the answer, I think, is this notion of a startup, where some group of people who are willing to try something differently say: Let us go off by ourselves. We'll develop both different laws, perhaps, but importantly, different norms about right and wrong. We'll reinforce that in our little culture that operates separately. And then, if these turn out to be a success and be better, we'll not only demonstrate to others that there's something which is better, but we'll also provide a mechanism where people can move from the equilibrium where one set of rules and norms prevails to this other one.

They can get socialized into those new rules, especially the norms, by exposure to them. And in a voluntary way without any coercion, you can move from one set of arrangements to another set of arrangements that are radically different, but at each step along the way, nobody was forced to change what they were doing here and adopt immediately what's working elsewhere.

MALLABY: So an analogy here would be between charter cities that you advocate in developing countries and charter schools in the United States. So one approach to school reform is to try to, you know, persuade people on the board of education to vote for a different -- choose a different superintendent and have, you know, reform from within.

ROMER: Yeah.

MALLABY: And then the alternative is to say that's really difficult because the existing school system sort of has a set of norms that are quite difficult to shift. So let's try reform from without through charter schools that sort of start out with new sets of norms.

ROMER: Yeah. So if you think about something like a KIPP school, it would be very hard to get a consensus with any existing school to shift this very different style of instruction and interaction with students at a KIPP school. But if you start a brand new one and say this is how it'll be run, students and teachers will go and try it out. But the charter schools lesson also has a caution for us, which is, I think, that if you don't operate at the right scale, you're not going to succeed.

I think that for dramatic change in education, you need to think at the level of a bigger system that probably is the scale of a city. So you need to change the whole governance structure, schooling in the city and how you measure performance and how you train people there.

So if you create these start-ups in a way which is too small and they're too dependent on the rest of the environment within which they work, they may be doomed to failure. And we've seen many countries around the world try to use this entity that they call a special economic zone, where they liberalize or change the rules in those zones, give firms the option to opt in there, so it has the elements I was describing before. But they're not self-sufficient; they're too dependent on the surrounding systems. And so they can't by themselves get the kind of success you could get if you took a city, which I think is, in many cases, the right unit to think about for doing things in a self-contained, comprehensive way.

MALLABY: And -- so another analogy is with the way that change takes place within business, and, you know, when IBM builds up a business, which is very, very good at selling big mainframes to corporate customers, and then along comes the personal computer and you've got to suddenly sell to individuals. It turned out that they had a lot of difficulty changing their business culture to be nimble enough to sell to individuals. And so another company sprung up from somewhere else, Dell or whatever, right?

So is that another good analogy with what you're --

ROMER: Yeah. There's -- I think there's a very fruitful analogy between cities and corporations, and they operate in an environment where they're competing with each other and start-ups can sometimes do things that the existing organizations can't do. And it helps, I think, guide certain intuitions that come to mind when we think about political change.

One of the very common reactions I get about a charter city is if you start at a brand new city with a particular set of rules, it might not succeed, it might not be a success like Hong Kong. To which my answer is, that's exactly right and we should start a number of them, just like we should start many small start-up firms. So the transition to the, you know, the computer on your desk and then the computer in your pocket, we think can remember the ones that succeeded; we don't remember all of the dozens or more that tried and failed. But the point at the level of the industry, and it will transfer to the world as a whole, is the cost of the failures is really extremely low. And the benefits of the successes are enormously important.

So we should be as open to the idea of brand new cities that start out and try and do things differently as we are to the options for brand new firms. And the one other thing that makes this so easy to do right now is that we live in a time where the world is desperately short on cities. You know, 3 billion people live in cities right now. In the next 30 years, 50 years, another 3 billion people will move into cities.

So we need to do urbanization on a scale that humans have never done before, more than we've done in all of history. And then the other interesting thing about this time is that once we've done it in this century, things will pretty much be over; we'll never again have the chance to influence the worldwide system of cities because we're going to reach a maximum population on Earth this century. We're going to reach probably a stable percentage of the population that lives in cities.

So one way or another, we're going to establish the system of cities for the whole world this century. And why not use it as a chance to try some things differently, do some things better rather than just grow by accretion all the -- all the many -- in many cases, badly run cities that exist right now.

MALLABY: I want to make sure that people understand how differently you're proposing, because you're saying not merely that there should be new start-up charter cities. You're saying that the people who run these cities ought to be outsiders, people from outside the country precisely to try to escape the existing rule set. You need, for example, if it's going to be Nigeria, that a consortium of European governments show up and start to run a new city, which may teach Lagos what it's done wrong.

ROMER: Yeah. This approach is one that could be used in many different places. So we'll talk -- come in a second and about Honduras where what you're describing is, I think, exactly what people in Honduras are expecting, that other governments will come in and help set up the governance for the new city they want to establish in Honduras. So think of it as a partnership between Honduras and a number of other governments who can bring both institutional credibility and administrative experience on basic things like the administration of law.

MALLABY: And we should just say for those who don't read the Central American newspapers every day that Honduras passed a constitutional amendment last week, which opens the way towards creating a charter city in Honduras and inviting foreigners to come in and administer.

ROMER: So we'll come back and talk about the specifics there in a moment. But I wanted to say that even though that might be the right model for Honduras, think about India right now. India might have a model where they create, entirely through their internal resources, brand new empty spaces where a new administration could be put in place and a whole new city could grow up.

So this idea of chartering an entirely new city could be something that's done entirely within a country, as China did with -- (word inaudible) -- next to Hong Kong, but in much of the developing world you have countries that are very small, that don't have the kinds of central resources that a country like India might have or countries like Honduras or many countries in sub-Saharan Africa. And there are kind of strong partnerships that, I think, could be exploited, will be critical to success. And the historical model that's worth keeping in mind here is that of Hong Kong.

If you think of Hong Kong as a piece of China where the British said, we'll do a partnership with China; we'll come in, we'll set up a new city here, and we'll see which Chinese want to come and live under a very different set of rules; Hong Kong was an enormous success for the people who came there and ultimately a success that I claim was pivotal in helping encourage the transition to the rapid growth we've seen since the late 1970s in China.

So -- and to bring it back to Honduras, they're very open to creating a new city where foreign partners might have a very decisive say on what takes place there.

MALLABY: And, you know, if one was to ask them, why would you give up control over some chunk of coastal land so that foreigners can come and run it for you, why do you think their political system has just voted with, I think, almost a unanimous majority in the congress there to endorse this idea? It's just counterintuitive that a country would hand over a chunk of land to foreigners. Why do you think that's politically feasible?

ROMER: So -- yeah, let's be -- let's be frank. This is a country which had a change in the leadership of the country in the previous presidency which was very irregular. And some people called it a coup. Others have said, well, you know, this person was breaking the law. But they had -- they had a president that was forcibly removed from office, a transition president and now a new set of leaders who were elected in the regularly scheduled elections.

But they understand that if they go to a major sovereign wealth fund and somebody with experience in airports and say, come invest billions of dollars to build a major airport here in Honduras; they understand that on their own, they're not going to have the credibility to say we can promise you that you're going to be able to operate in a stable environment for the next 50 years and your rights as an investor will be protected and the health, safety, water, electricity, all these things will be managed relatively well; they simply don't have the credibility to make that commitment.

But they understand -- in a way, it's just like if I went to someone and said, look, I want to buy a house. I'm a good guy. Lend me -- you know, lend me a million dollars and trust me. It just -- it would never work. I mean, I give up sovereignty over my house to a judge, and I say to the judge, I'm promising to pay these guys back. If I don't pay them back, then you've got to come and take my house away from me. Giving away sovereignty over my house lets me do a deal with the mortgage leader I could never do on my own.

And the government in Honduras sees that they're in exactly that same position vis-a-vis this enormous supply of worldwide financial capital and technological experience that's extremely eager to find places to invest in things like infrastructure all over the world. But right now, they're kind of like me and the mortgage lender on our own. They just can't get the deal done unless there's somebody who could guarantee that both sides will stick to the terms of the deal.

MALLABY: Paul Collier at Oxford, and I guess to some extent Steve Krasner, your colleague at Stanford, have talked around this idea as well. So I think, you know, what they've observed is that a lack of credible rules has been a major impediment to development, to the attraction of inward investment, as you described.

And they've advocated various sort of steps short of what you're saying. In other words, you know, if you sign up for the World Trade Organization, you're effectively adopting binding commitments from outside to promise investors that you will have sensible rules on commerce. And that's a kind of commitment mechanism that proves you're serious. And you're saying, you know, let's go beyond that and just take a discrete chunk of territory and hand over the whole control for 50 years, for some long period.

ROMER: Yeah, yeah. I think it's -- given the importance of this problem and the importance of the gains from trade if we could facilitate these long-term investments from the rich and fast-growing countries, the gains are so large that we should be willing to experiment with a number of different mechanisms.

But I think if you look at attempts that have been made to do this and you look at what kinds of things went wrong, it gives you pause about the -- you know, sort of the simple solutions others have asked -- others have proposed.

Let me give you some examples. Singapore was very successful in developing a city within its boundaries, and they started to ask: How can we go out and develop other cities like this in other parts of the world?

So they developed an extremely large industrial park, really a small-scale city on Batam Island in Indonesia. They also tried to develop a very large site outside of Shanghai in China. And in each case, it wasn't that some government came in and just expropriated the physical capital that they had put in place, but there were a series of subtle changes -- it's what I call death by a thousand cuts -- which took opportunities, which were very -- well, in Indonesia, it was very successful for a while, and then the government changed certain parts of labor regulation and just destroyed the viability of these investments.

In China, it was the opposite case, where they had put in all the infrastructure in the ground and then no businesses were willing to come because the local governments were sending all these subtle signals about things that -- things could go wrong in this zone if foreigners came and invested in the Singapore zone instead of one the city wanted to develop.

And I'm told there were stories like, you'd show up at this huge industrial park that Singapore was developing, and there'd be a big pile of dirt on the road blocking entrance. And you'd call the local government trying to figure out, who do we get to move the pile of dirt, and nobody knew. And Lee Kuan Yew would personally call Deng Xiaoping and say, you know, who could -- who do I got to talk to to move that pile of dirt? And, you know, Deng Xiaoping doesn't have any clue.

So the kinds of ex -- post-opportunistic behavior you can get subjected to here is subtle and has a lot to do not just with the law, which is important, to be sure, but also things like just local administration, the competence of the civil service, the transparency of the civil service.

And so bringing in a country that has experience with transparent, open, visible administration, regulation and legislation can be a way to quickly to the equilibrium that will really provide confidence for the investors.

MALLABY: So, I mean, just to sum up here, so supposing we take Honduras as an example, and the argument is that, you know, for umpteen years, World Bank missions have visited Honduras, and they've said, you know, you've got a governance problem; you need to do various kinds of reforms to fix your rules so that you get a better growth. And the problem is the entrenched elites or the system in general is too ossified -- it's like IBM setting its mainframes -- and it cannot make this switch to a better equilibrium of better rules.

So now you say, okay --

ROMER: Although, let me make one slight nuance there. Think of this partly as two sides, both of which are very afraid of being taken advantage by the other side. So you've got people with historical claims to large amounts of land who feel very threatened by peasants who are talking about, you know, like land invasions and seizures of land.

On the other hand, you have peasants and low-wage workers who feel like the landowners have taken advantage of special access through the legal system to get a position that is unjustified and they may do even more. So it's not just ossification, but a real fear on either side that if you created some government entity with some power, one or the other side is going to grab ahold of it and use it to disadvantage the other.

MALLABY: Right. But so for complex political economy reasons, it's tough to get the reform that would really stimulate growth. The creation of the better rules is difficult. And we've tried this for a long time. So now let's think outside the box, and instead of trying to get the Honduran polity to reform itself, let's have this charter city -- like a charter school, let's start off a rival, where you have on this coastal piece of land a consortium, and it's the Swiss government, and in alliance with the Dutch and Danish governments. And they come in together. They've got extremely good rules in their own countries. They understand transparency. They understand rule of law. They have fantastic rules in this new city. And now they're going to attract all kinds of investment.

But isn't the threat of the pile of debt outside the charter city, put there by the jealous mayor from the local Honduran city, isn't that still there?

ROMER: So first, in the sequence here, part of how you get that transparency and you deal with a lot of the internal problems is that the Dutch and the Swiss -- and I forget who was your third, but they all agree to appoint an individual who is like the strong mayor, the executive, who has lots of discretionary powers, a very clear mandate, but whose job it is to get things done and hold that person accountable. So, strong executive leadership is very important.

MALLABY: Are you a candidate?

ROMER: No. (Chuckles.) Nobody who's been a university professor is a candidate for an executive position. (Laughter.)

MALLABY: Even the son of a former state governor?

ROMER: No. But then this gets back to my comment about why cities are important and things smaller than cities don't work. If this is on a coastal location, with its own port, with its own airport, its own power system, you could have literal walls to grow up on the border with the rest of Honduras, and this little entity becomes a self-sufficient city-state that thrives, just like Hong Kong thrived when mainland China was going through the cultural revolution.

And so in the conversations in Honduras, what the president and the members of Congress understand is they need to create an arrangement which is strong enough so that an investor says to him- or herself, my investment there will be viable, in the sense that my rights will be protected, but also in the sense that this will be thriving city, no matter what happens in Honduras. Even if there's, you know, revolution and violence and chaos in Honduras, this is big enough, this is self-contained, this will thrive no matter what.

MALLABY: I'm going to open up in a second to members. I'll just ask a final question, which is, what's the chances, realistically, that any developed country wants to take on this responsibility? Because you're sort of positing that they would actually resort to force of arms to defend this enclave if they needed to. Otherwise, it's not credible.

ROMER: Yeah. I think because of the recent experience in Afghanistan and Iraq, developed countries are going to be very hesitant about military commitments that in some sense they feel like they can't deliver on. But this is a commitment which is easy to deliver on, and I think it won't be hard to persuade people of this.

The line in the sand where someone has to invade across that line to cause a violation is extremely important because it so clearly signals the violation of the law, of international law. So think of the invasion by Iraq of Kuwait. It was not hard to mobilize people around the world, because this was wrong and had to be resisted, and it wasn't hard to push it back.

So that's not the problem. The problem that we face right now is when there's a group of people where the mission is to try and impose order on people where some of those people never asked for these outsiders to come in and use violence to impose order. And so I think it's a radically different situation where there are some people who have said, we want to live under these conditions where you help protect our borders; and, you know, we as citizens of the city will staff, you know, the national service entity that helps protect those things; we just need your commitment of, you know, freedom of navigation of the seas and, you know, a little bit of support.

That's a radically different situation than trying to go in and force a security or policing system on a population where some people might like it but the others become, you know, the rioters in Haiti right now or the National Liberation Movement that resists our presence in Iraq --

MALLABY: People in the city have voted with their feet. They've chosen to be there.

ROMER: Exactly. Everybody -- this is why Hong Kong had such a different experience than most other colonial ventures by the British; that everybody who lived there came there knowing full well what the arrangements would be, and those arrangements had a legitimacy, because of that choice to opt in, that anything that's imposed against people's will can never have.

MALLABY: Okay. Let's open it up. Who's got a question? Mitzi, here in the front. So please stand and state your name.

QUESTIONER: I'm Mitzi Wertheim with the Naval Postgraduate School. I started working for IBM the day they had their PC, and I watched this transformation. They transformed themselves by selling off things. And I'm -- a little unclear to me how cities can sell off things. That's just a question.

I also have a question about scale. And if you're going to create a new city, one of the things you have to have is an initial investment to build the infrastructure. And it's not clear to me where -- because that's substantial, whether it's electricity or whether it's sewage or whatever. Where does that money come from?

MALLABY: The financing question.

ROMER: Yep. And your questions are very closely linked. So let me take the financing one first.

There is an enormous amount of financial resources around the world that is very interested in infrastructure investment. They see this as exactly the kind of investment they want, guaranteed high returns for decades into the future. And these -- like these sovereign wealth funds and private investors have been totally burned by chasing the wave for the last -- you know, the last decade. So there's a huge amount of financial resources there.

What's missing is an environment where they can make those investments and be free of political risk. So the money is there if you can create the -- if you can create the political entity that would protect it.

QUESTIONER: (Off mic) -- right kind of people.

ROMER: Well, so then think about how this plays out. The airport, who would finance an airport? If this is going to be a city of 10 million people, lots of people would agree to finance the airport in exchange for the ability to just collect the landing fees there for both the passengers and the cargo that come through. Who would build the power system? You know, a firm that can charge for the electricity at the kind of rates we pay. Who would build the water system? So there's an awful lot of investment that could come in just based on self-interest on the part of the investors.

But what you need is a government which is strong enough to do two things: one, ensure that the initial deal that you make with the investors is respected from the side of the residents and the fee payers and the government; but on the other side, equally important, to guarantee that the firms stick to what they promise when they come in, because in many developing countries, they promise the world, they come in, they're the monopoly provider, and they say, oh, you know, I know we said X, but you're going to pay, you know, 2.5 times X or you don't have any water tomorrow.

So you need a strong government to protect, because both sides can behave badly in this kind of arrangement.

Now, one other thing. Who's going to pay for the schools here? Outside investors are not going to come in and pay for the schools. If you think about a tract of land, like a thousand square kilometers, which is what we're talking about here, it's about -- it's bigger than the size of either Singapore or Hong Kong; and you think about what that land would be worth -- it's worth nothing now, essentially -- you think about what that land would be worth if there were a city like Hong Kong or Singapore that was built there, it's just hundreds of billions of dollars in potential gain in the land itself, separate from what you have to pay for the buildings, the ports and power system and so forth.

There's a way to give the governing entity the returns on the value it's going to create in that land and use those returns as the way to pay for the basic services like policing and education, minimal health care, that make this a really attractive place to come to. So there's a way to do this that doesn't require any charity, that just harnesses mutually beneficial exchange, as long as we create an environment where people can safely contract with each other and do deals.

MALLABY: I should point out that in the U.S. foreign assistance context, we have two things going on right now: a big, announced desire to reform USAID and have new ideas, which is good for your idea; and a huge budgetary constraint, which might be good for your idea too.

Another question. In the middle.

QUESTIONER: Bob Winter with Arnold & Porter. What is the relationship between the new city-state and the rest of Honduras? And what happens if people join the city-state and then decide they really don't like it? And does the government of Honduras gain anything in the way of taxation, and therefore does it in fact have some control over the city-state?

And finally, trying to understand how this would operate in practicality, is the city-state run by an executive with, you know, a number of Danes and the like, or is it democratic? And if it's democratic, what do you do if you have the types of divisions within the city-state that you have in the rest of Honduras? And what leads you to believe that that will radically change?

ROMER: So let me work backwards again. All of this is under discussion right now. Very little of it is set in stone. To just be clear about the procedures here, there is a constitutional amendment which specifies what the Congress in Honduras can do in creating special development regions. And that specifies a few items about what are the powers of the Congress in that region as opposed to what would be the powers within the region. And the thrust of the amendment is to create enormous flexibility for some new government entity in that region to operate independently of the government.

So I guess I -- and now going back to your first part, things like fiscal transfers between the two have yet to be worked out. They haven't -- there's a second stage, where they have enabling legislation for a particular site, that will probably specify things like the involvement of partner governments in, say, appointing the strong mayor. And there may be some arrangements for fiscal transfers back and forth. They may decide that the smartest thing for Honduras and Hondurans is to not require any fiscal transfers at all and just make sure this thing right next to them is a big success.

Now, the Hondurans that I've spoken to think that in the early stages, it would be better -- it would be more attractive to Hondurans if, when they go to this city, they don't have a vote over who that executive in charge of the city is. So both some of the rich land-holding families who might want to invest there, some of the peasants who are landless and very frustrated about that, both sides may find it more attractive to go to a place where they know that the mayor was picked by the Danes and the Swiss rather than selected through some democratic process which could lead to one side taking advantage of the other side through, you know, patronage and militias and all the kinds of things we see around the world.

So the people in Honduras will make this call, but they may say not only will the foreign investors be happier if there aren't elections for the mayor in this place for many years; the firms who come in and hire people may also be more comfortable; the residents may actually be more comfortable, as well, going some place where they don't inject the kind of insecurity they've had to live with for so long in Honduras in this new place.

MALLABY: So when you go there, you don't get a vote, but by virtue of having gone there, you have already voted with your feet.

ROMER: Yeah. And by the way, I think it's absolutely essential for any country who sets up something like this, and for the world as a whole, to insist on not just a de-jure but a de-facto exit option for people, that no one should ever be trapped in one of these places. So they vote with their feet to come in, but they should always be free to leave if they don't like what they find.

MALLABY: Instead of the choice that cross-border migrants make all the time. They leave Honduras; they don't go to a charter city because there isn't one; they come to the United States, they don't get to vote here, at least at first, and they've chosen that. They've opted in.

ROMER: Yeah. I mean, if you think about the choice right now, a Honduran who comes to the United States typically has to leave his family behind -- suppose he's going to come work in construction. He leaves his family behind. He's going to live illegally in the United States, has no hope of voting for who the mayor is wherever he lives in the United States, and he's got a one-in-seven chance of being kidnapped and held for ransom by a Mexican gang on the transit to the United States.

So it's not very hard to imagine that a place close by, where he could take his family, where he could live as a permanent resident and have the same kind of economic opportunity he's seeking in the United States -- it's not very hard to imagine it being preferable to go to that place as opposed to come to the U.S. the way they do now.

MALLABY: Yeah, a question right here.

QUESTIONER: Hi. Rebecca Patterson, the Kauffman Foundation. I was just wondering if you could talk about the opting-in process, if there is some sort of selection criteria that you can -- you prevent spoilers.

ROMER: Again, this is something where the Hondurans will have to make their own choices. There are a few things that economic theory suggests going in. There's an issue like the one we face about health insurance and pre-existing conditions. You would be dangerous to start this by saying, well, for example, we guarantee that we're going to provide very large transfers for anybody who has some kind of disadvantage, because what happens is then you select a whole population that are committed to transfers.

In the same way, it'd be a disaster to say, "Well, we, the Honduran government, are going to give a whole bunch of tax concessions and payments for firms that will come and create jobs," because then what you do is attract a whole bunch of firms who are committed to, you know, bad equilibria with -- you know, with transfer payments and rent-seeking from the government. So you've got to set these rules up so that the people who come in come in because they want opportunity and they want to -- they want to work.

When you think about security issues, another question that I've raised is whether or not they want to think about, in some sense, the burden of proof when you ask someone to leave to be different from the burden of proof when you say, why not incarcerate someone for violating the law?

And I think they may well opt for the notion that, in principle, this city is available to anybody from Honduras, and they're committed to the idea this -- that this will be for the whole region as well, but that there may be conditions for coming to this place, like participation in something like national service, and conditions in terms of attachment to the workforce or going to school. And if you don't meet those kinds of conditions, you may just be asked to leave. You know, they might decide it's simply not an option in this city to be unemployed and not in school and just a source of -- a source of potential problems.

MALLABY: Another question. Fred here.

QUESTIONER: Thank you. Fred Tipson with the U.N. Development Program here in Washington. I wanted to ask you whether you'd looked at Jeff Sachs' Millennium Villages approach. But actually, I lived in Hong Kong twice, and I -- the analogy is fascinating, but it strikes me as --

ROMER: To what year? What years?

QUESTIONER: I was there from -- let's see: (1988/1998 ?) -- '91 and then '98 to 2001. So ten years apart.

ROMER: So ('88 ?) to '91.

QUESTIONER: Both before and after the transition.

ROMER: Okay. So you had -- okay. (Inaudible.)

QUESTIONER: Yeah.

But the question is really which analogy to Hong Kong's history is the relevant one. Because, as you know, in the beginning, the Scottish trading houses were the ones -- and the conditions for people were abysmal for, you know, most people in Hong Kong except for the British civil servants.

But then if you're talking about the take-off period, really so much depended on the influx of these powerful families from Shanghai who ran the businesses. And, of course, Hong Kong was a managed economy by the British -- still is a managed economy. And the notion of local people just had a whole -- you know, there -- a lot of people were in transition when I was there. People were getting their green cards to be able to have an exit strategy. It's a city that was -- that basically for the take-off period was building on the ability to manufacture in China, very cheap labor, almost forced labor conditions that entrepreneurs in China were able to take advantage of.

I just don't see these analogies coming true in Honduras. But I know you've probably thought deeply about the analogy and how it -- how maybe it does instruct how this can be done more effectively.

ROMER: Yeah. Yeah. I think the right -- the right picture to have in mind is Hong Kong in 1950, because then the prospect of the takeover by mainland China was very distant, so everybody was anticipating British administration. And this was a place where somebody from mainline China could come and get their first paying job, their first job with a wage -- and that's almost always in garment assembly -- I mean, we just see this over and over again all around the world -- then later into something like toys, light manufacturing. I mean, most of us in this room can remember what "Made in Hong Kong" meant when we were -- we were kids.

Those people didn't earn very much. They lived in tiny apartments. But that job and that apartment was a big step up for them from what they had on the mainland. And that job in particular, especially a formal-sector job with a firm that pays a wage and follows rules and enforces certain kinds of patterns of interaction with other people in the firm, there's a training -- an on-the-job education that comes from that kind of job, which is incredibly important for people who want to improve their quality of life.

So I think we have to be very open to the -- to the -- to the economic reality that the first jobs that most people will hold in, say, this new city in Honduras will be jobs that pay very little to be competitive with the worldwide garment industry and light manufacturing. They're going to live in tiny apartments, by our standards, fewer meters per person than we would -- we would ever want for ourselves.

But when they go there, they'll be telling us they're going there because that's better than the other options they've got, and because they know that there's a future like the future for all the -- virtually all the Chinese who went there in the 1950s who all rode the wave up into incredibly rapid increases in average income per capita.

MALLABY: But you could extend the point, I think, because if the analogy is Hong Kong in 1950, then by the time Fred moves to Hong Kong in the late '80s and there is -- then this interaction with Shenzhen and the building up of the hinterland and the interaction between the capitalists in Hong Kong and the sweatshops, and if that's -- that's also part of the vision here -- right? --

ROMER: Yup.

MALLABY: -- that the charter city ultimately does create spill-overs into the hinterland which are going to be good for the hinterland.

ROMER: Yeah. But, you know, and who knows how long it might take, but 20 years, 30 years, this charter city in Honduras might look like Hong Kong today or New York today, and there won't be any garment assembly or any toy manufacturing going on there, but it will now be a service and cultural and finance center which is serving other locations where people will still be going to get their first job in manufacturing. And those could be other locations adjacent to this location in Honduras, but it could be other locations that are just a plane ride or a ship ride away throughout Central America.

MALLABY: Right over here. You've been very patient. Thank you.

QUESTIONER: I'm Maureen Lewis from the World Bank. And I like out-of-the-box thinking, and I think this really falls under that category. And it's a very interesting idea.

I do have a couple of worries, having spent some time in Latin America.

One is that I gather there will be courts, but there don't need to be any jails, because you can send people away. I mean, it -- that's sort of a shorthand. But --

ROMER: My guess is there probably will be jails, too.

QUESTIONER: There will be jails. Okay. So you do have that cost.

But I think fundamentally I worry about two things.

One is the economic -- the economic viability of it depends on labor, basically, because you're going to bring in the capital, and you have the land, so that there's a little bit of a constraint there, given the problems that Honduras has had in the past in terms of a labor force that is not really prepared particularly well. And the garment -- the garment industry is very competitive worldwide. It's really hard to break into that, for many reasons that you can probably explain to me better than I can explain. That's one.

But the other issue that I do come back to is the political stability and what the guarantees are for investors against political upheaval. All it takes is a Chavez, and today you have this gleaming city, and tomorrow you're, you know, at the mercy of somebody who really is not going to abide by any of the rules that a previous government agreed to.

ROMER: So you have to -- you have to kind of scenario plan for something like this. So -- this won't happen, so I can use his name, but you know, Michael Bloomberg agrees that being president is really not very interesting, and Michael Bloomberg takes over and he's running this -- he's running this new city in Honduras. He gets to build a brand-new city from scratch.

And he's got commitments. He's appointed by the Swiss, the Canadians, the Norwegians. He's got investments that brings in the infrastructure and then the firms.

And remember, this isn't just a problem of getting access to cheap labor. The thing about cities is they create enormous value when they're well-run. So you're getting all of these gains from bringing millions of people in and letting them interact with each other really, really intensely. So that's the value he's creating.

And then Chavez takes over the rest of Honduras. You know, Bloomberg goes: Fine. You know, cross the border -- you better be shooting when you cross the border, because you can't come in. And he just -- he keeps running his city; goods are coming in and out of the port; planes are taking off, flying in and out, just like Hong Kong during the Cultural Revolution. You know, what's the problem?

Chavez says: Well, we -- you know, we tore up the old constitution. This is our land.

Bloomberg says: Okay. Well, what are you going to do? Drive across the border shooting?

MALLABY: I think it's worth sort of underlining a point you, I think, were getting at earlier --

ROMER: Yeah.

MALLABY: -- that there's a hierarchy of international commitments, some of which are violated very, very easily --

ROMER: Yup.

MALLABY: -- and don't have much credibility, and others to do with clearly demarcated borders. In fact, the record is that when people violate those and they come across shooting --

ROMER: Yeah.

MALLABY: -- then there is an international response.

ROMER: Yeah. I mean, the reason I'm sort of being provocative about this is that people don't -- I mean, almost nobody, except for, you know, Saddam Hussein in Kuwait, has tried this ploy recently. The only other one was the Argentines trying to take back the Falkland Islands.

So it's really implausible that any -- you know, that any leader in any surrounding region would try and mount a military invasion, because even countries who hadn't, say, signed on as, you know, people who help appoint the mayor are going to react to such a -- you know, such a brazen attempt at, you know, violating, you know, the sovereignty or the integrity of a political jurisdiction.

So I think what you should worry about are not the invasions but the subtle -- kind of the potential for death by a thousand cuts. And so, you know, this is exactly what people are talking about in Honduras right now with the constitutional amendment. Constitution reserves for the government of Honduras control of the air -- the air rights over this -- over this area. That can't be delegated under the constitution without more changes than they wanted to make to the -- to Bloomberg. So Bloomberg can't control air traffic over his city.

But Bloomberg can go out and sign treaties with many nations around the world that guarantee free passage of air traffic, just like the treaties we use that guarantee innocent passage through maritime waters. And then if the Chavez-like leader wants to say, well, our air traffic guys aren't letting any planes take off in and out of your -- you know, in and out of your city, well, now he's got a beef with nations all over the world because he's violating treaty commitments to all of them, not just an internal dispute with this -- with the city. And then -- you know, then what's to stop Bloomberg from just saying, you know, we've got our own air traffic controllers now; we direct the planes when to take off?

So you can -- you can scenario plan fairly specific kinds of circumstances here, but the overriding thing you can come back to is that there's no economic reason why a city like this couldn't be set so that it can be totally viable regardless of what happens in the rest of Honduras. And so if you plan for what would happen if the rest of Honduras plunges into chaos, then you can be confident that actually it'll never happen. Yeah.

MALLABY: (Inaudible) -- in the back.

QUESTIONER: Hi. Amanda Sloat. I'm intrigued by the idea, but it seems if you take a more cynical approach, it smacks a bit of postmodern colonialism, that you have an underdeveloped country and so you have a bunch of wealthy Western nations with spare capital looking for an easy place to make money and have the cheap labor and come in and effectively build a town off the back of a poorer country. So I'd be curious to hear your response to that

And second, how some of these governance arrangements actually work. I mean, you've used the example of Hong Kong, but that was effectively a British colony, and so there was a sense of British ownership or responsibility for what happened there. And in your scenario with Michael Bloomberg, if Honduras sinks into conflict, who's responsible? I mean, if it's attacked, is it some, you know, NATO Charter 5 issue if there's a Michael Bloomberg and the U.S. is on board? Militarily, who responds? I mean, I -- it's not going to be the Swiss. Is it -- is it going to be the Danes or somebody else?

And what happens if your Michael Bloomberg viceroy, you know, becomes sort of a despotic character who's doing untoward things in the city-state? Who's then responsible for overseeing him and removing him if he becomes problematic?

ROMER: Yeah. So on the first question, we often use words to invoke a feeling without necessarily focusing on what the words mean.

So think about the case of those 75,000 Hondurans each year who migrate to the United States at great risk to themselves, at huge financial cost, serious risk to their personal security and a very unattractive legal status when they get to the United States.

Is that postmodern colonialism, that they want to come live under the kinds of conditions that we want our children to have available for where they live and work? You can call it postmodern colonialism, but I don't see what it buys you. If people want something, I think we should give them the choice and let them decide for themselves what's right for them. And the tragedy right now is there's no place nearby that people can go without risk of being kidnapped, take their families, live legally, know that their kids will get an education. And it can't possibly be a bad thing to create some more choices like that, given the ones that Hondurans are already making.

Now, the other practical question you alluded to is who makes sure that Michael Bloomberg doesn't misbehave? That's built into the basic law, so not the constitutional amendment, but the basic law, which we anticipate will have a structure where there are representatives on some kind of a board -- like somebody nominated by the Swiss, somebody nominated by Canada, somebody by Denmark, who appoint the mayor, hold the mayor accountable, make a decision about reappointment. So it's, in many ways, it's just like the kind of arrangement we have with Ben Bernanke. He's got a lot of freedom to do stuff on a day-to-day basis, but there's a clear mandate for what he's supposed to accomplish and a clear provision for reappointment for selecting a successor.

So this is not at all like suggestions that we revert to some form of authoritarian rule. This is absolutely built in from the beginning, democratic accountability for this chief executive. But that doesn't have to mean democratic accountability in the sense of a locally run election. There can be other representatives, other democracies that hold an executive like this accountable. And as I said before, if there is a real threat, I think it's much more likely to be the kind of threat that, say, drug gangs present in Mexico right now or that Chavez presents in other countries, which, to a large extent, are just open intimidation through threats of physical violence, which you have to prevent by a security force that makes sure that that's never a successful strategy.

The other thing which we're seeing just pervasively is manipulation of the political system by the drug gangs, by Chavez and the like. And so part of what might make people more comfortable to go to someplace where the mayor was appointed by the Danes and the Canadians is they know that it's not going to be subverted by enough money from the drug gangs or the Chavez types.

So I think it's likely to be a very attractive arrangement in a part of the world where things are very, very unstable right now.

MALLABY: Okay. We've got time for one more question. Before we take it, I want to remind people that this is on the record. And we'll go over here for the last question. Wait for the microphone, please.

QUESTIONER: I hope this is fair, I'm related to the speaker.

MALLABY: Yes, yes. Perhaps you could tell everybody who you are. (Scattered laughter.)

QUESTIONER: As an observer of the American political scene, as a governor and as the chairman of the national Democratic Party, I am very interested in this fact that this out-of-the-box idea is being pushed by Honduras that changed its constitution. It didn't talk about it; it did it last week. That is in an atmosphere in which this nation, for years, has been trying to do its own form of intervention and economic development, which has a pretty bad record.

It would seem there is a real, should be a real audience in this country for another way at least to contrast.

So my question is -- because all new ideas that come to this city are given a pretty hard time -- the question is, is our posture to be, sit back and let's see what happens? We'll watch them, you know, go their way and join five years from now? Or do we have an obligation or an opportunity as a group of organizations in a nation that care about change to create a more viable alternative? In short, in one sentence, I'm fascinated that the driving force this particular week comes from Honduras as contrasted to the United States.

MALLABY: Well, the question from Governor Romer to Professor Romer was actually maybe a question for the rest of the people in the room, but if you want to take a last minute or so to just wrap it up, that would be great.

ROMER: Well, let me just say one fact here, which is that this idea started first in Honduras. People there were talking about the idea of could they persuade a nation to establish an embassy in Honduras where the grounds of the embassy would be several hundred square kilometers and they were hoping that somehow the international law of embassies would mean that they would have extraterritoriality and could set up a new city there in Honduras.

So that was the discussion that people there in Honduras were having when they heard about the more abstract discussions I'd been having about charter cities. So they came to me and they've taken some things I've suggested and they've, you know, modified, rejected other things that I've suggested. But this is something which is coming from the people of Honduras who really desperately perceive the need to vote, initiate growth, but make sure that growth is inclusive and get past histories -- a history of animosity and fear in their country, which has just been holding them back ever since the first European contact.

So I think -- my view is that if I can answer your question, I think we should be ready to be as helpful as we can. The world doesn't have enough experiments and enough places where a country says, we're willing to try something different. So I hope I've persuaded at least a few of you to keep an open mind about being receptive to what they're doing and maybe even being helpful.

UNAUTHORIZED REPRODUCTION, REDISTRIBUTION OR RETRANSMISSION CONSTITUTES A MISAPPROPRIATION UNDER APPLICABLE UNFAIR COMPETITION LAW, AND FEDERAL NEWS SERVICE, INC. RESERVES THE RIGHT TO PURSUE ALL REMEDIES AVAILABLE TO IT IN RESPECT TO SUCH MISAPPROPRIATION.

FEDERAL NEWS SERVICE, INC. IS A PRIVATE FIRM AND IS NOT AFFILIATED WITH THE FEDERAL GOVERNMENT. NO COPYRIGHT IS CLAIMED AS TO ANY PART OF THE ORIGINAL WORK PREPARED BY A UNITED STATES GOVERNMENT OFFICER OR EMPLOYEE AS PART OF THAT PERSON'S OFFICIAL DUTIES.

FOR INFORMATION ON SUBSCRIBING TO FNS, PLEASE CALL 202-347-1400 OR E-MAIL INFO@FEDNEWS.COM.

THIS IS A RUSH TRANSCRIPT.

-------------------------

SEBASTIAN MALLABY: (In progress.) Also importantly, please turn off those things that go beep and vibrate and so forth, because it messes up the sound system.

Here, we're here with Paul Romer, who is the Henry Kaufman visiting professor at the New York Stern School, but more deeply and broadly than that, has a very varied and interesting trajectory, starting as an economic theorist, mostly at Stanford; known in the 1990s as the father of new growth theory, which stresses that the traditional inputs into people's growth models -- labor, capital and so forth -- were inadequate, and that they left out the crucial role of ideas, and that once you started to understand that, it had big implications for how you could kick-start or accelerate growth, both in rich countries like the U.S., but also, importantly, in poor countries.

After that, Paul set up a -- an education software company, which he ultimately sold. He tells me that he didn't sell it at such a price that he's rich by Silicon Valley standards, but nonetheless it was very successful.

And then in the last two or three years, he's devoted most of his energy to something called the charter cities movement, which is what we're going to discuss.

So let's start there, Paul. I mean, tell us, you know, what is the charter cities idea, and what drew you to devote all your energy to it?

PAUL ROMER: Yeah. Let me actually take it in reverse order and say where this idea first came from. When I was in Chicago, when I was a professor there before I went to Stanford, there was a woman who worked for my wife and me. My wife was in a residency program, so this woman helped cook and clean in our house. And she lived in the Cabrini-Green housing project in Chicago, which as many of you know is one of the most desperate failures in our public housing system. And the question that struck me, when I saw her and these two young children she was raising, is why she didn't have a chance to move to a city which could offer simple things like relatively low-cost housing and low crime. She simply didn't have that option in the United States. And I started to ask why couldn't it be possible to create entirely new cities that could offer options like that for someone like her.

So that idea has stayed with me now for 25 years. And the application now is in -- is in the developing world, where there are hundreds of millions -- really, billions of people who are in the same position that she's in. And the charter cities movement is about taking seriously the idea that we could build entirely new cities that could present a different range of options to the least-advantaged people on Earth.

MALLABY: And this links back to your theoretical work on what drives growth, because as you explained, ideas are not merely new technologies. They're also, very importantly, rules, right?

ROMER: Yeah. Yeah. There's a -- there's a saying we use to explain that -- what's unique about ideas, their shareability. And I'm sure you all know it, but if you give someone a fish, you feed them for a day, but if you teach someone to fish -- you destroy another aquatic ecosystem. (Laughter.)

And what that suggests is, is that new ideas like trawlers and nets are things that we can share and use all over the world. But if we don't have advances in our rules, say that limit the catch in a fishery along with technological advances, those new technologies could do more harm than good.

In the developing-world context, the problem is often that the rules prevent valuable technologies. One I talk about a lot is just electrical light in the house, a hundred-year-old technology that still isn't available to many poor people all over the world. There -- that technology is not being made available to them because of the local rules that prevent it. And so I switched from thinking about how can we invent new improvements beyond electrical light, to thinking about how can we have improvements, innovation, diffusion of better rules alongside of innovation and diffusion of better technologies.

MALLABY: So in other words, the very fact that there are a lot of technologies that have existed for a long time, but yet are not actually adopted, suggests that it's the conditions for adoption that might matter more than the technologies themselves.

ROMER: Yeah, absolutely. And it's easy to think, oh, well, the poor people can't afford new technologies. But if you look at something like water, this ancient technology for delivering municipal water through pipes and taps, that technology's cheaper than the ones that poor people pay to get their water delivered to them in most slums around the world. So it's not that people -- poor people can't afford to pay for some of these modern technologies, but something deep in the system is preventing the development of something like a municipal water system that provides lower-cost, safer water.

MALLABY: Safer than having the water brought to you in some plastic container that --

ROMER: Yeah, plastic jug from a truck, from an unknown source.

MALLABY: Right. Right. Right. I mean, you use a very arresting image to get this point across sometimes, which is this photograph of kids doing their homework in an African city under a street light. And the kids probably have cell phones?

ROMER: Yeah.

MALLABY: Which is a newer technology than electric lighting. But they obviously do not have electric lighting at home. Otherwise, they would be doing their homework at home.

ROMER: Right.

MALLABY: So I guess this leads to the question, you know, people have observed for maybe 20 years, at the World Bank and other development organizations, that governance is very important, that rules matter, that institutions matter.

ROMER: Mm-hmm.

MALLABY: The question is: How do you actually encourage countries to improve their governance? I mean, and that's where you have some ideas as well.

ROMER: Yeah. Sure. So one suggestion I'm making at every opportunity is, let's take that word "institutions" and just stop using it. It's just too confusing and it's too vague, so think about rules. And when you -- every time you think about rules, think about laws and social norms about what's right and wrong. So the challenge is: How can we take an existing set of laws and norms, and change them to get to a new set of laws and norms?

I think one of the problems in the debate is we focused too much on the laws; we didn't think enough about the importance of norms. I think we also tended to assume that when there were bad rules in place, we wanted to look for a bad person to blame; like who's the bad person in charge? Who's the elite that's stifling opportunity for others? Let's find a bad person to blame, and then somehow change that person, and then we'll get to good rules. And I think that is just a dead end. It just doesn't correspond to the facts.

What we see are collections of people who all behave according to a given set of rules, and it's simply not possible, even for the leaders, to unilaterally change those -- change those rules in context. So we've got to figure out why is it hard for all these people, who can see that there are better rules, to not be able to change their rules, and then historically, what has actually worked to allow a change in rules when the -- kind of the frontal assault often fails.

MALLABY: So what's the answer?

ROMER: So the answer, I think, is this notion of a startup, where some group of people who are willing to try something differently say: Let us go off by ourselves. We'll develop both different laws, perhaps, but importantly, different norms about right and wrong. We'll reinforce that in our little culture that operates separately. And then, if these turn out to be a success and be better, we'll not only demonstrate to others that there's something which is better, but we'll also provide a mechanism where people can move from the equilibrium where one set of rules and norms prevails to this other one.

They can get socialized into those new rules, especially the norms, by exposure to them. And in a voluntary way without any coercion, you can move from one set of arrangements to another set of arrangements that are radically different, but at each step along the way, nobody was forced to change what they were doing here and adopt immediately what's working elsewhere.

MALLABY: So an analogy here would be between charter cities that you advocate in developing countries and charter schools in the United States. So one approach to school reform is to try to, you know, persuade people on the board of education to vote for a different -- choose a different superintendent and have, you know, reform from within.

ROMER: Yeah.

MALLABY: And then the alternative is to say that's really difficult because the existing school system sort of has a set of norms that are quite difficult to shift. So let's try reform from without through charter schools that sort of start out with new sets of norms.

ROMER: Yeah. So if you think about something like a KIPP school, it would be very hard to get a consensus with any existing school to shift this very different style of instruction and interaction with students at a KIPP school. But if you start a brand new one and say this is how it'll be run, students and teachers will go and try it out. But the charter schools lesson also has a caution for us, which is, I think, that if you don't operate at the right scale, you're not going to succeed.

I think that for dramatic change in education, you need to think at the level of a bigger system that probably is the scale of a city. So you need to change the whole governance structure, schooling in the city and how you measure performance and how you train people there.

So if you create these start-ups in a way which is too small and they're too dependent on the rest of the environment within which they work, they may be doomed to failure. And we've seen many countries around the world try to use this entity that they call a special economic zone, where they liberalize or change the rules in those zones, give firms the option to opt in there, so it has the elements I was describing before. But they're not self-sufficient; they're too dependent on the surrounding systems. And so they can't by themselves get the kind of success you could get if you took a city, which I think is, in many cases, the right unit to think about for doing things in a self-contained, comprehensive way.

MALLABY: And -- so another analogy is with the way that change takes place within business, and, you know, when IBM builds up a business, which is very, very good at selling big mainframes to corporate customers, and then along comes the personal computer and you've got to suddenly sell to individuals. It turned out that they had a lot of difficulty changing their business culture to be nimble enough to sell to individuals. And so another company sprung up from somewhere else, Dell or whatever, right?

So is that another good analogy with what you're --

ROMER: Yeah. There's -- I think there's a very fruitful analogy between cities and corporations, and they operate in an environment where they're competing with each other and start-ups can sometimes do things that the existing organizations can't do. And it helps, I think, guide certain intuitions that come to mind when we think about political change.

One of the very common reactions I get about a charter city is if you start at a brand new city with a particular set of rules, it might not succeed, it might not be a success like Hong Kong. To which my answer is, that's exactly right and we should start a number of them, just like we should start many small start-up firms. So the transition to the, you know, the computer on your desk and then the computer in your pocket, we think can remember the ones that succeeded; we don't remember all of the dozens or more that tried and failed. But the point at the level of the industry, and it will transfer to the world as a whole, is the cost of the failures is really extremely low. And the benefits of the successes are enormously important.

So we should be as open to the idea of brand new cities that start out and try and do things differently as we are to the options for brand new firms. And the one other thing that makes this so easy to do right now is that we live in a time where the world is desperately short on cities. You know, 3 billion people live in cities right now. In the next 30 years, 50 years, another 3 billion people will move into cities.

So we need to do urbanization on a scale that humans have never done before, more than we've done in all of history. And then the other interesting thing about this time is that once we've done it in this century, things will pretty much be over; we'll never again have the chance to influence the worldwide system of cities because we're going to reach a maximum population on Earth this century. We're going to reach probably a stable percentage of the population that lives in cities.

So one way or another, we're going to establish the system of cities for the whole world this century. And why not use it as a chance to try some things differently, do some things better rather than just grow by accretion all the -- all the many -- in many cases, badly run cities that exist right now.

MALLABY: I want to make sure that people understand how differently you're proposing, because you're saying not merely that there should be new start-up charter cities. You're saying that the people who run these cities ought to be outsiders, people from outside the country precisely to try to escape the existing rule set. You need, for example, if it's going to be Nigeria, that a consortium of European governments show up and start to run a new city, which may teach Lagos what it's done wrong.

ROMER: Yeah. This approach is one that could be used in many different places. So we'll talk -- come in a second and about Honduras where what you're describing is, I think, exactly what people in Honduras are expecting, that other governments will come in and help set up the governance for the new city they want to establish in Honduras. So think of it as a partnership between Honduras and a number of other governments who can bring both institutional credibility and administrative experience on basic things like the administration of law.

MALLABY: And we should just say for those who don't read the Central American newspapers every day that Honduras passed a constitutional amendment last week, which opens the way towards creating a charter city in Honduras and inviting foreigners to come in and administer.

ROMER: So we'll come back and talk about the specifics there in a moment. But I wanted to say that even though that might be the right model for Honduras, think about India right now. India might have a model where they create, entirely through their internal resources, brand new empty spaces where a new administration could be put in place and a whole new city could grow up.

So this idea of chartering an entirely new city could be something that's done entirely within a country, as China did with -- (word inaudible) -- next to Hong Kong, but in much of the developing world you have countries that are very small, that don't have the kinds of central resources that a country like India might have or countries like Honduras or many countries in sub-Saharan Africa. And there are kind of strong partnerships that, I think, could be exploited, will be critical to success. And the historical model that's worth keeping in mind here is that of Hong Kong.

If you think of Hong Kong as a piece of China where the British said, we'll do a partnership with China; we'll come in, we'll set up a new city here, and we'll see which Chinese want to come and live under a very different set of rules; Hong Kong was an enormous success for the people who came there and ultimately a success that I claim was pivotal in helping encourage the transition to the rapid growth we've seen since the late 1970s in China.

So -- and to bring it back to Honduras, they're very open to creating a new city where foreign partners might have a very decisive say on what takes place there.

MALLABY: And, you know, if one was to ask them, why would you give up control over some chunk of coastal land so that foreigners can come and run it for you, why do you think their political system has just voted with, I think, almost a unanimous majority in the congress there to endorse this idea? It's just counterintuitive that a country would hand over a chunk of land to foreigners. Why do you think that's politically feasible?

ROMER: So -- yeah, let's be -- let's be frank. This is a country which had a change in the leadership of the country in the previous presidency which was very irregular. And some people called it a coup. Others have said, well, you know, this person was breaking the law. But they had -- they had a president that was forcibly removed from office, a transition president and now a new set of leaders who were elected in the regularly scheduled elections.

But they understand that if they go to a major sovereign wealth fund and somebody with experience in airports and say, come invest billions of dollars to build a major airport here in Honduras; they understand that on their own, they're not going to have the credibility to say we can promise you that you're going to be able to operate in a stable environment for the next 50 years and your rights as an investor will be protected and the health, safety, water, electricity, all these things will be managed relatively well; they simply don't have the credibility to make that commitment.

But they understand -- in a way, it's just like if I went to someone and said, look, I want to buy a house. I'm a good guy. Lend me -- you know, lend me a million dollars and trust me. It just -- it would never work. I mean, I give up sovereignty over my house to a judge, and I say to the judge, I'm promising to pay these guys back. If I don't pay them back, then you've got to come and take my house away from me. Giving away sovereignty over my house lets me do a deal with the mortgage leader I could never do on my own.

And the government in Honduras sees that they're in exactly that same position vis-a-vis this enormous supply of worldwide financial capital and technological experience that's extremely eager to find places to invest in things like infrastructure all over the world. But right now, they're kind of like me and the mortgage lender on our own. They just can't get the deal done unless there's somebody who could guarantee that both sides will stick to the terms of the deal.

MALLABY: Paul Collier at Oxford, and I guess to some extent Steve Krasner, your colleague at Stanford, have talked around this idea as well. So I think, you know, what they've observed is that a lack of credible rules has been a major impediment to development, to the attraction of inward investment, as you described.

And they've advocated various sort of steps short of what you're saying. In other words, you know, if you sign up for the World Trade Organization, you're effectively adopting binding commitments from outside to promise investors that you will have sensible rules on commerce. And that's a kind of commitment mechanism that proves you're serious. And you're saying, you know, let's go beyond that and just take a discrete chunk of territory and hand over the whole control for 50 years, for some long period.

ROMER: Yeah, yeah. I think it's -- given the importance of this problem and the importance of the gains from trade if we could facilitate these long-term investments from the rich and fast-growing countries, the gains are so large that we should be willing to experiment with a number of different mechanisms.

But I think if you look at attempts that have been made to do this and you look at what kinds of things went wrong, it gives you pause about the -- you know, sort of the simple solutions others have asked -- others have proposed.

Let me give you some examples. Singapore was very successful in developing a city within its boundaries, and they started to ask: How can we go out and develop other cities like this in other parts of the world?

So they developed an extremely large industrial park, really a small-scale city on Batam Island in Indonesia. They also tried to develop a very large site outside of Shanghai in China. And in each case, it wasn't that some government came in and just expropriated the physical capital that they had put in place, but there were a series of subtle changes -- it's what I call death by a thousand cuts -- which took opportunities, which were very -- well, in Indonesia, it was very successful for a while, and then the government changed certain parts of labor regulation and just destroyed the viability of these investments.

In China, it was the opposite case, where they had put in all the infrastructure in the ground and then no businesses were willing to come because the local governments were sending all these subtle signals about things that -- things could go wrong in this zone if foreigners came and invested in the Singapore zone instead of one the city wanted to develop.

And I'm told there were stories like, you'd show up at this huge industrial park that Singapore was developing, and there'd be a big pile of dirt on the road blocking entrance. And you'd call the local government trying to figure out, who do we get to move the pile of dirt, and nobody knew. And Lee Kuan Yew would personally call Deng Xiaoping and say, you know, who could -- who do I got to talk to to move that pile of dirt? And, you know, Deng Xiaoping doesn't have any clue.

So the kinds of ex -- post-opportunistic behavior you can get subjected to here is subtle and has a lot to do not just with the law, which is important, to be sure, but also things like just local administration, the competence of the civil service, the transparency of the civil service.

And so bringing in a country that has experience with transparent, open, visible administration, regulation and legislation can be a way to quickly to the equilibrium that will really provide confidence for the investors.

MALLABY: So, I mean, just to sum up here, so supposing we take Honduras as an example, and the argument is that, you know, for umpteen years, World Bank missions have visited Honduras, and they've said, you know, you've got a governance problem; you need to do various kinds of reforms to fix your rules so that you get a better growth. And the problem is the entrenched elites or the system in general is too ossified -- it's like IBM setting its mainframes -- and it cannot make this switch to a better equilibrium of better rules.

So now you say, okay --

ROMER: Although, let me make one slight nuance there. Think of this partly as two sides, both of which are very afraid of being taken advantage by the other side. So you've got people with historical claims to large amounts of land who feel very threatened by peasants who are talking about, you know, like land invasions and seizures of land.

On the other hand, you have peasants and low-wage workers who feel like the landowners have taken advantage of special access through the legal system to get a position that is unjustified and they may do even more. So it's not just ossification, but a real fear on either side that if you created some government entity with some power, one or the other side is going to grab ahold of it and use it to disadvantage the other.

MALLABY: Right. But so for complex political economy reasons, it's tough to get the reform that would really stimulate growth. The creation of the better rules is difficult. And we've tried this for a long time. So now let's think outside the box, and instead of trying to get the Honduran polity to reform itself, let's have this charter city -- like a charter school, let's start off a rival, where you have on this coastal piece of land a consortium, and it's the Swiss government, and in alliance with the Dutch and Danish governments. And they come in together. They've got extremely good rules in their own countries. They understand transparency. They understand rule of law. They have fantastic rules in this new city. And now they're going to attract all kinds of investment.

But isn't the threat of the pile of debt outside the charter city, put there by the jealous mayor from the local Honduran city, isn't that still there?

ROMER: So first, in the sequence here, part of how you get that transparency and you deal with a lot of the internal problems is that the Dutch and the Swiss -- and I forget who was your third, but they all agree to appoint an individual who is like the strong mayor, the executive, who has lots of discretionary powers, a very clear mandate, but whose job it is to get things done and hold that person accountable. So, strong executive leadership is very important.

MALLABY: Are you a candidate?

ROMER: No. (Chuckles.) Nobody who's been a university professor is a candidate for an executive position. (Laughter.)

MALLABY: Even the son of a former state governor?

ROMER: No. But then this gets back to my comment about why cities are important and things smaller than cities don't work. If this is on a coastal location, with its own port, with its own airport, its own power system, you could have literal walls to grow up on the border with the rest of Honduras, and this little entity becomes a self-sufficient city-state that thrives, just like Hong Kong thrived when mainland China was going through the cultural revolution.

And so in the conversations in Honduras, what the president and the members of Congress understand is they need to create an arrangement which is strong enough so that an investor says to him- or herself, my investment there will be viable, in the sense that my rights will be protected, but also in the sense that this will be thriving city, no matter what happens in Honduras. Even if there's, you know, revolution and violence and chaos in Honduras, this is big enough, this is self-contained, this will thrive no matter what.

MALLABY: I'm going to open up in a second to members. I'll just ask a final question, which is, what's the chances, realistically, that any developed country wants to take on this responsibility? Because you're sort of positing that they would actually resort to force of arms to defend this enclave if they needed to. Otherwise, it's not credible.

ROMER: Yeah. I think because of the recent experience in Afghanistan and Iraq, developed countries are going to be very hesitant about military commitments that in some sense they feel like they can't deliver on. But this is a commitment which is easy to deliver on, and I think it won't be hard to persuade people of this.

The line in the sand where someone has to invade across that line to cause a violation is extremely important because it so clearly signals the violation of the law, of international law. So think of the invasion by Iraq of Kuwait. It was not hard to mobilize people around the world, because this was wrong and had to be resisted, and it wasn't hard to push it back.

So that's not the problem. The problem that we face right now is when there's a group of people where the mission is to try and impose order on people where some of those people never asked for these outsiders to come in and use violence to impose order. And so I think it's a radically different situation where there are some people who have said, we want to live under these conditions where you help protect our borders; and, you know, we as citizens of the city will staff, you know, the national service entity that helps protect those things; we just need your commitment of, you know, freedom of navigation of the seas and, you know, a little bit of support.

That's a radically different situation than trying to go in and force a security or policing system on a population where some people might like it but the others become, you know, the rioters in Haiti right now or the National Liberation Movement that resists our presence in Iraq --

MALLABY: People in the city have voted with their feet. They've chosen to be there.

ROMER: Exactly. Everybody -- this is why Hong Kong had such a different experience than most other colonial ventures by the British; that everybody who lived there came there knowing full well what the arrangements would be, and those arrangements had a legitimacy, because of that choice to opt in, that anything that's imposed against people's will can never have.

MALLABY: Okay. Let's open it up. Who's got a question? Mitzi, here in the front. So please stand and state your name.

QUESTIONER: I'm Mitzi Wertheim with the Naval Postgraduate School. I started working for IBM the day they had their PC, and I watched this transformation. They transformed themselves by selling off things. And I'm -- a little unclear to me how cities can sell off things. That's just a question.

I also have a question about scale. And if you're going to create a new city, one of the things you have to have is an initial investment to build the infrastructure. And it's not clear to me where -- because that's substantial, whether it's electricity or whether it's sewage or whatever. Where does that money come from?

MALLABY: The financing question.

ROMER: Yep. And your questions are very closely linked. So let me take the financing one first.

There is an enormous amount of financial resources around the world that is very interested in infrastructure investment. They see this as exactly the kind of investment they want, guaranteed high returns for decades into the future. And these -- like these sovereign wealth funds and private investors have been totally burned by chasing the wave for the last -- you know, the last decade. So there's a huge amount of financial resources there.

What's missing is an environment where they can make those investments and be free of political risk. So the money is there if you can create the -- if you can create the political entity that would protect it.

QUESTIONER: (Off mic) -- right kind of people.

ROMER: Well, so then think about how this plays out. The airport, who would finance an airport? If this is going to be a city of 10 million people, lots of people would agree to finance the airport in exchange for the ability to just collect the landing fees there for both the passengers and the cargo that come through. Who would build the power system? You know, a firm that can charge for the electricity at the kind of rates we pay. Who would build the water system? So there's an awful lot of investment that could come in just based on self-interest on the part of the investors.

But what you need is a government which is strong enough to do two things: one, ensure that the initial deal that you make with the investors is respected from the side of the residents and the fee payers and the government; but on the other side, equally important, to guarantee that the firms stick to what they promise when they come in, because in many developing countries, they promise the world, they come in, they're the monopoly provider, and they say, oh, you know, I know we said X, but you're going to pay, you know, 2.5 times X or you don't have any water tomorrow.

So you need a strong government to protect, because both sides can behave badly in this kind of arrangement.

Now, one other thing. Who's going to pay for the schools here? Outside investors are not going to come in and pay for the schools. If you think about a tract of land, like a thousand square kilometers, which is what we're talking about here, it's about -- it's bigger than the size of either Singapore or Hong Kong; and you think about what that land would be worth -- it's worth nothing now, essentially -- you think about what that land would be worth if there were a city like Hong Kong or Singapore that was built there, it's just hundreds of billions of dollars in potential gain in the land itself, separate from what you have to pay for the buildings, the ports and power system and so forth.

There's a way to give the governing entity the returns on the value it's going to create in that land and use those returns as the way to pay for the basic services like policing and education, minimal health care, that make this a really attractive place to come to. So there's a way to do this that doesn't require any charity, that just harnesses mutually beneficial exchange, as long as we create an environment where people can safely contract with each other and do deals.

MALLABY: I should point out that in the U.S. foreign assistance context, we have two things going on right now: a big, announced desire to reform USAID and have new ideas, which is good for your idea; and a huge budgetary constraint, which might be good for your idea too.

Another question. In the middle.

QUESTIONER: Bob Winter with Arnold & Porter. What is the relationship between the new city-state and the rest of Honduras? And what happens if people join the city-state and then decide they really don't like it? And does the government of Honduras gain anything in the way of taxation, and therefore does it in fact have some control over the city-state?

And finally, trying to understand how this would operate in practicality, is the city-state run by an executive with, you know, a number of Danes and the like, or is it democratic? And if it's democratic, what do you do if you have the types of divisions within the city-state that you have in the rest of Honduras? And what leads you to believe that that will radically change?

ROMER: So let me work backwards again. All of this is under discussion right now. Very little of it is set in stone. To just be clear about the procedures here, there is a constitutional amendment which specifies what the Congress in Honduras can do in creating special development regions. And that specifies a few items about what are the powers of the Congress in that region as opposed to what would be the powers within the region. And the thrust of the amendment is to create enormous flexibility for some new government entity in that region to operate independently of the government.

So I guess I -- and now going back to your first part, things like fiscal transfers between the two have yet to be worked out. They haven't -- there's a second stage, where they have enabling legislation for a particular site, that will probably specify things like the involvement of partner governments in, say, appointing the strong mayor. And there may be some arrangements for fiscal transfers back and forth. They may decide that the smartest thing for Honduras and Hondurans is to not require any fiscal transfers at all and just make sure this thing right next to them is a big success.

Now, the Hondurans that I've spoken to think that in the early stages, it would be better -- it would be more attractive to Hondurans if, when they go to this city, they don't have a vote over who that executive in charge of the city is. So both some of the rich land-holding families who might want to invest there, some of the peasants who are landless and very frustrated about that, both sides may find it more attractive to go to a place where they know that the mayor was picked by the Danes and the Swiss rather than selected through some democratic process which could lead to one side taking advantage of the other side through, you know, patronage and militias and all the kinds of things we see around the world.

So the people in Honduras will make this call, but they may say not only will the foreign investors be happier if there aren't elections for the mayor in this place for many years; the firms who come in and hire people may also be more comfortable; the residents may actually be more comfortable, as well, going some place where they don't inject the kind of insecurity they've had to live with for so long in Honduras in this new place.

MALLABY: So when you go there, you don't get a vote, but by virtue of having gone there, you have already voted with your feet.

ROMER: Yeah. And by the way, I think it's absolutely essential for any country who sets up something like this, and for the world as a whole, to insist on not just a de-jure but a de-facto exit option for people, that no one should ever be trapped in one of these places. So they vote with their feet to come in, but they should always be free to leave if they don't like what they find.

MALLABY: Instead of the choice that cross-border migrants make all the time. They leave Honduras; they don't go to a charter city because there isn't one; they come to the United States, they don't get to vote here, at least at first, and they've chosen that. They've opted in.

ROMER: Yeah. I mean, if you think about the choice right now, a Honduran who comes to the United States typically has to leave his family behind -- suppose he's going to come work in construction. He leaves his family behind. He's going to live illegally in the United States, has no hope of voting for who the mayor is wherever he lives in the United States, and he's got a one-in-seven chance of being kidnapped and held for ransom by a Mexican gang on the transit to the United States.

So it's not very hard to imagine that a place close by, where he could take his family, where he could live as a permanent resident and have the same kind of economic opportunity he's seeking in the United States -- it's not very hard to imagine it being preferable to go to that place as opposed to come to the U.S. the way they do now.

MALLABY: Yeah, a question right here.

QUESTIONER: Hi. Rebecca Patterson, the Kauffman Foundation. I was just wondering if you could talk about the opting-in process, if there is some sort of selection criteria that you can -- you prevent spoilers.

ROMER: Again, this is something where the Hondurans will have to make their own choices. There are a few things that economic theory suggests going in. There's an issue like the one we face about health insurance and pre-existing conditions. You would be dangerous to start this by saying, well, for example, we guarantee that we're going to provide very large transfers for anybody who has some kind of disadvantage, because what happens is then you select a whole population that are committed to transfers.

In the same way, it'd be a disaster to say, "Well, we, the Honduran government, are going to give a whole bunch of tax concessions and payments for firms that will come and create jobs," because then what you do is attract a whole bunch of firms who are committed to, you know, bad equilibria with -- you know, with transfer payments and rent-seeking from the government. So you've got to set these rules up so that the people who come in come in because they want opportunity and they want to -- they want to work.

When you think about security issues, another question that I've raised is whether or not they want to think about, in some sense, the burden of proof when you ask someone to leave to be different from the burden of proof when you say, why not incarcerate someone for violating the law?

And I think they may well opt for the notion that, in principle, this city is available to anybody from Honduras, and they're committed to the idea this -- that this will be for the whole region as well, but that there may be conditions for coming to this place, like participation in something like national service, and conditions in terms of attachment to the workforce or going to school. And if you don't meet those kinds of conditions, you may just be asked to leave. You know, they might decide it's simply not an option in this city to be unemployed and not in school and just a source of -- a source of potential problems.

MALLABY: Another question. Fred here.

QUESTIONER: Thank you. Fred Tipson with the U.N. Development Program here in Washington. I wanted to ask you whether you'd looked at Jeff Sachs' Millennium Villages approach. But actually, I lived in Hong Kong twice, and I -- the analogy is fascinating, but it strikes me as --

ROMER: To what year? What years?

QUESTIONER: I was there from -- let's see: (1988/1998 ?) -- '91 and then '98 to 2001. So ten years apart.

ROMER: So ('88 ?) to '91.

QUESTIONER: Both before and after the transition.

ROMER: Okay. So you had -- okay. (Inaudible.)

QUESTIONER: Yeah.

But the question is really which analogy to Hong Kong's history is the relevant one. Because, as you know, in the beginning, the Scottish trading houses were the ones -- and the conditions for people were abysmal for, you know, most people in Hong Kong except for the British civil servants.

But then if you're talking about the take-off period, really so much depended on the influx of these powerful families from Shanghai who ran the businesses. And, of course, Hong Kong was a managed economy by the British -- still is a managed economy. And the notion of local people just had a whole -- you know, there -- a lot of people were in transition when I was there. People were getting their green cards to be able to have an exit strategy. It's a city that was -- that basically for the take-off period was building on the ability to manufacture in China, very cheap labor, almost forced labor conditions that entrepreneurs in China were able to take advantage of.

I just don't see these analogies coming true in Honduras. But I know you've probably thought deeply about the analogy and how it -- how maybe it does instruct how this can be done more effectively.

ROMER: Yeah. Yeah. I think the right -- the right picture to have in mind is Hong Kong in 1950, because then the prospect of the takeover by mainland China was very distant, so everybody was anticipating British administration. And this was a place where somebody from mainline China could come and get their first paying job, their first job with a wage -- and that's almost always in garment assembly -- I mean, we just see this over and over again all around the world -- then later into something like toys, light manufacturing. I mean, most of us in this room can remember what "Made in Hong Kong" meant when we were -- we were kids.

Those people didn't earn very much. They lived in tiny apartments. But that job and that apartment was a big step up for them from what they had on the mainland. And that job in particular, especially a formal-sector job with a firm that pays a wage and follows rules and enforces certain kinds of patterns of interaction with other people in the firm, there's a training -- an on-the-job education that comes from that kind of job, which is incredibly important for people who want to improve their quality of life.

So I think we have to be very open to the -- to the -- to the economic reality that the first jobs that most people will hold in, say, this new city in Honduras will be jobs that pay very little to be competitive with the worldwide garment industry and light manufacturing. They're going to live in tiny apartments, by our standards, fewer meters per person than we would -- we would ever want for ourselves.

But when they go there, they'll be telling us they're going there because that's better than the other options they've got, and because they know that there's a future like the future for all the -- virtually all the Chinese who went there in the 1950s who all rode the wave up into incredibly rapid increases in average income per capita.

MALLABY: But you could extend the point, I think, because if the analogy is Hong Kong in 1950, then by the time Fred moves to Hong Kong in the late '80s and there is -- then this interaction with Shenzhen and the building up of the hinterland and the interaction between the capitalists in Hong Kong and the sweatshops, and if that's -- that's also part of the vision here -- right? --

ROMER: Yup.

MALLABY: -- that the charter city ultimately does create spill-overs into the hinterland which are going to be good for the hinterland.

ROMER: Yeah. But, you know, and who knows how long it might take, but 20 years, 30 years, this charter city in Honduras might look like Hong Kong today or New York today, and there won't be any garment assembly or any toy manufacturing going on there, but it will now be a service and cultural and finance center which is serving other locations where people will still be going to get their first job in manufacturing. And those could be other locations adjacent to this location in Honduras, but it could be other locations that are just a plane ride or a ship ride away throughout Central America.

MALLABY: Right over here. You've been very patient. Thank you.

QUESTIONER: I'm Maureen Lewis from the World Bank. And I like out-of-the-box thinking, and I think this really falls under that category. And it's a very interesting idea.

I do have a couple of worries, having spent some time in Latin America.

One is that I gather there will be courts, but there don't need to be any jails, because you can send people away. I mean, it -- that's sort of a shorthand. But --

ROMER: My guess is there probably will be jails, too.

QUESTIONER: There will be jails. Okay. So you do have that cost.

But I think fundamentally I worry about two things.

One is the economic -- the economic viability of it depends on labor, basically, because you're going to bring in the capital, and you have the land, so that there's a little bit of a constraint there, given the problems that Honduras has had in the past in terms of a labor force that is not really prepared particularly well. And the garment -- the garment industry is very competitive worldwide. It's really hard to break into that, for many reasons that you can probably explain to me better than I can explain. That's one.

But the other issue that I do come back to is the political stability and what the guarantees are for investors against political upheaval. All it takes is a Chavez, and today you have this gleaming city, and tomorrow you're, you know, at the mercy of somebody who really is not going to abide by any of the rules that a previous government agreed to.

ROMER: So you have to -- you have to kind of scenario plan for something like this. So -- this won't happen, so I can use his name, but you know, Michael Bloomberg agrees that being president is really not very interesting, and Michael Bloomberg takes over and he's running this -- he's running this new city in Honduras. He gets to build a brand-new city from scratch.

And he's got commitments. He's appointed by the Swiss, the Canadians, the Norwegians. He's got investments that brings in the infrastructure and then the firms.

And remember, this isn't just a problem of getting access to cheap labor. The thing about cities is they create enormous value when they're well-run. So you're getting all of these gains from bringing millions of people in and letting them interact with each other really, really intensely. So that's the value he's creating.

And then Chavez takes over the rest of Honduras. You know, Bloomberg goes: Fine. You know, cross the border -- you better be shooting when you cross the border, because you can't come in. And he just -- he keeps running his city; goods are coming in and out of the port; planes are taking off, flying in and out, just like Hong Kong during the Cultural Revolution. You know, what's the problem?

Chavez says: Well, we -- you know, we tore up the old constitution. This is our land.

Bloomberg says: Okay. Well, what are you going to do? Drive across the border shooting?

MALLABY: I think it's worth sort of underlining a point you, I think, were getting at earlier --

ROMER: Yeah.

MALLABY: -- that there's a hierarchy of international commitments, some of which are violated very, very easily --

ROMER: Yup.

MALLABY: -- and don't have much credibility, and others to do with clearly demarcated borders. In fact, the record is that when people violate those and they come across shooting --

ROMER: Yeah.

MALLABY: -- then there is an international response.

ROMER: Yeah. I mean, the reason I'm sort of being provocative about this is that people don't -- I mean, almost nobody, except for, you know, Saddam Hussein in Kuwait, has tried this ploy recently. The only other one was the Argentines trying to take back the Falkland Islands.

So it's really implausible that any -- you know, that any leader in any surrounding region would try and mount a military invasion, because even countries who hadn't, say, signed on as, you know, people who help appoint the mayor are going to react to such a -- you know, such a brazen attempt at, you know, violating, you know, the sovereignty or the integrity of a political jurisdiction.

So I think what you should worry about are not the invasions but the subtle -- kind of the potential for death by a thousand cuts. And so, you know, this is exactly what people are talking about in Honduras right now with the constitutional amendment. Constitution reserves for the government of Honduras control of the air -- the air rights over this -- over this area. That can't be delegated under the constitution without more changes than they wanted to make to the -- to Bloomberg. So Bloomberg can't control air traffic over his city.

But Bloomberg can go out and sign treaties with many nations around the world that guarantee free passage of air traffic, just like the treaties we use that guarantee innocent passage through maritime waters. And then if the Chavez-like leader wants to say, well, our air traffic guys aren't letting any planes take off in and out of your -- you know, in and out of your city, well, now he's got a beef with nations all over the world because he's violating treaty commitments to all of them, not just an internal dispute with this -- with the city. And then -- you know, then what's to stop Bloomberg from just saying, you know, we've got our own air traffic controllers now; we direct the planes when to take off?

So you can -- you can scenario plan fairly specific kinds of circumstances here, but the overriding thing you can come back to is that there's no economic reason why a city like this couldn't be set so that it can be totally viable regardless of what happens in the rest of Honduras. And so if you plan for what would happen if the rest of Honduras plunges into chaos, then you can be confident that actually it'll never happen. Yeah.

MALLABY: (Inaudible) -- in the back.

QUESTIONER: Hi. Amanda Sloat. I'm intrigued by the idea, but it seems if you take a more cynical approach, it smacks a bit of postmodern colonialism, that you have an underdeveloped country and so you have a bunch of wealthy Western nations with spare capital looking for an easy place to make money and have the cheap labor and come in and effectively build a town off the back of a poorer country. So I'd be curious to hear your response to that

And second, how some of these governance arrangements actually work. I mean, you've used the example of Hong Kong, but that was effectively a British colony, and so there was a sense of British ownership or responsibility for what happened there. And in your scenario with Michael Bloomberg, if Honduras sinks into conflict, who's responsible? I mean, if it's attacked, is it some, you know, NATO Charter 5 issue if there's a Michael Bloomberg and the U.S. is on board? Militarily, who responds? I mean, I -- it's not going to be the Swiss. Is it -- is it going to be the Danes or somebody else?

And what happens if your Michael Bloomberg viceroy, you know, becomes sort of a despotic character who's doing untoward things in the city-state? Who's then responsible for overseeing him and removing him if he becomes problematic?

ROMER: Yeah. So on the first question, we often use words to invoke a feeling without necessarily focusing on what the words mean.

So think about the case of those 75,000 Hondurans each year who migrate to the United States at great risk to themselves, at huge financial cost, serious risk to their personal security and a very unattractive legal status when they get to the United States.

Is that postmodern colonialism, that they want to come live under the kinds of conditions that we want our children to have available for where they live and work? You can call it postmodern colonialism, but I don't see what it buys you. If people want something, I think we should give them the choice and let them decide for themselves what's right for them. And the tragedy right now is there's no place nearby that people can go without risk of being kidnapped, take their families, live legally, know that their kids will get an education. And it can't possibly be a bad thing to create some more choices like that, given the ones that Hondurans are already making.

Now, the other practical question you alluded to is who makes sure that Michael Bloomberg doesn't misbehave? That's built into the basic law, so not the constitutional amendment, but the basic law, which we anticipate will have a structure where there are representatives on some kind of a board -- like somebody nominated by the Swiss, somebody nominated by Canada, somebody by Denmark, who appoint the mayor, hold the mayor accountable, make a decision about reappointment. So it's, in many ways, it's just like the kind of arrangement we have with Ben Bernanke. He's got a lot of freedom to do stuff on a day-to-day basis, but there's a clear mandate for what he's supposed to accomplish and a clear provision for reappointment for selecting a successor.

So this is not at all like suggestions that we revert to some form of authoritarian rule. This is absolutely built in from the beginning, democratic accountability for this chief executive. But that doesn't have to mean democratic accountability in the sense of a locally run election. There can be other representatives, other democracies that hold an executive like this accountable. And as I said before, if there is a real threat, I think it's much more likely to be the kind of threat that, say, drug gangs present in Mexico right now or that Chavez presents in other countries, which, to a large extent, are just open intimidation through threats of physical violence, which you have to prevent by a security force that makes sure that that's never a successful strategy.

The other thing which we're seeing just pervasively is manipulation of the political system by the drug gangs, by Chavez and the like. And so part of what might make people more comfortable to go to someplace where the mayor was appointed by the Danes and the Canadians is they know that it's not going to be subverted by enough money from the drug gangs or the Chavez types.

So I think it's likely to be a very attractive arrangement in a part of the world where things are very, very unstable right now.

MALLABY: Okay. We've got time for one more question. Before we take it, I want to remind people that this is on the record. And we'll go over here for the last question. Wait for the microphone, please.

QUESTIONER: I hope this is fair, I'm related to the speaker.

MALLABY: Yes, yes. Perhaps you could tell everybody who you are. (Scattered laughter.)

QUESTIONER: As an observer of the American political scene, as a governor and as the chairman of the national Democratic Party, I am very interested in this fact that this out-of-the-box idea is being pushed by Honduras that changed its constitution. It didn't talk about it; it did it last week. That is in an atmosphere in which this nation, for years, has been trying to do its own form of intervention and economic development, which has a pretty bad record.

It would seem there is a real, should be a real audience in this country for another way at least to contrast.

So my question is -- because all new ideas that come to this city are given a pretty hard time -- the question is, is our posture to be, sit back and let's see what happens? We'll watch them, you know, go their way and join five years from now? Or do we have an obligation or an opportunity as a group of organizations in a nation that care about change to create a more viable alternative? In short, in one sentence, I'm fascinated that the driving force this particular week comes from Honduras as contrasted to the United States.

MALLABY: Well, the question from Governor Romer to Professor Romer was actually maybe a question for the rest of the people in the room, but if you want to take a last minute or so to just wrap it up, that would be great.

ROMER: Well, let me just say one fact here, which is that this idea started first in Honduras. People there were talking about the idea of could they persuade a nation to establish an embassy in Honduras where the grounds of the embassy would be several hundred square kilometers and they were hoping that somehow the international law of embassies would mean that they would have extraterritoriality and could set up a new city there in Honduras.

So that was the discussion that people there in Honduras were having when they heard about the more abstract discussions I'd been having about charter cities. So they came to me and they've taken some things I've suggested and they've, you know, modified, rejected other things that I've suggested. But this is something which is coming from the people of Honduras who really desperately perceive the need to vote, initiate growth, but make sure that growth is inclusive and get past histories -- a history of animosity and fear in their country, which has just been holding them back ever since the first European contact.

So I think -- my view is that if I can answer your question, I think we should be ready to be as helpful as we can. The world doesn't have enough experiments and enough places where a country says, we're willing to try something different. So I hope I've persuaded at least a few of you to keep an open mind about being receptive to what they're doing and maybe even being helpful.

UNAUTHORIZED REPRODUCTION, REDISTRIBUTION OR RETRANSMISSION CONSTITUTES A MISAPPROPRIATION UNDER APPLICABLE UNFAIR COMPETITION LAW, AND FEDERAL NEWS SERVICE, INC. RESERVES THE RIGHT TO PURSUE ALL REMEDIES AVAILABLE TO IT IN RESPECT TO SUCH MISAPPROPRIATION.

FEDERAL NEWS SERVICE, INC. IS A PRIVATE FIRM AND IS NOT AFFILIATED WITH THE FEDERAL GOVERNMENT. NO COPYRIGHT IS CLAIMED AS TO ANY PART OF THE ORIGINAL WORK PREPARED BY A UNITED STATES GOVERNMENT OFFICER OR EMPLOYEE AS PART OF THAT PERSON'S OFFICIAL DUTIES.

FOR INFORMATION ON SUBSCRIBING TO FNS, PLEASE CALL 202-347-1400 OR E-MAIL INFO@FEDNEWS.COM.

THIS IS A RUSH TRANSCRIPT.

-------------------------

SEBASTIAN MALLABY: (In progress.) Also importantly, please turn off those things that go beep and vibrate and so forth, because it messes up the sound system.

Here, we're here with Paul Romer, who is the Henry Kaufman visiting professor at the New York Stern School, but more deeply and broadly than that, has a very varied and interesting trajectory, starting as an economic theorist, mostly at Stanford; known in the 1990s as the father of new growth theory, which stresses that the traditional inputs into people's growth models -- labor, capital and so forth -- were inadequate, and that they left out the crucial role of ideas, and that once you started to understand that, it had big implications for how you could kick-start or accelerate growth, both in rich countries like the U.S., but also, importantly, in poor countries.

After that, Paul set up a -- an education software company, which he ultimately sold. He tells me that he didn't sell it at such a price that he's rich by Silicon Valley standards, but nonetheless it was very successful.

And then in the last two or three years, he's devoted most of his energy to something called the charter cities movement, which is what we're going to discuss.

So let's start there, Paul. I mean, tell us, you know, what is the charter cities idea, and what drew you to devote all your energy to it?

PAUL ROMER: Yeah. Let me actually take it in reverse order and say where this idea first came from. When I was in Chicago, when I was a professor there before I went to Stanford, there was a woman who worked for my wife and me. My wife was in a residency program, so this woman helped cook and clean in our house. And she lived in the Cabrini-Green housing project in Chicago, which as many of you know is one of the most desperate failures in our public housing system. And the question that struck me, when I saw her and these two young children she was raising, is why she didn't have a chance to move to a city which could offer simple things like relatively low-cost housing and low crime. She simply didn't have that option in the United States. And I started to ask why couldn't it be possible to create entirely new cities that could offer options like that for someone like her.

So that idea has stayed with me now for 25 years. And the application now is in -- is in the developing world, where there are hundreds of millions -- really, billions of people who are in the same position that she's in. And the charter cities movement is about taking seriously the idea that we could build entirely new cities that could present a different range of options to the least-advantaged people on Earth.

MALLABY: And this links back to your theoretical work on what drives growth, because as you explained, ideas are not merely new technologies. They're also, very importantly, rules, right?

ROMER: Yeah. Yeah. There's a -- there's a saying we use to explain that -- what's unique about ideas, their shareability. And I'm sure you all know it, but if you give someone a fish, you feed them for a day, but if you teach someone to fish -- you destroy another aquatic ecosystem. (Laughter.)

And what that suggests is, is that new ideas like trawlers and nets are things that we can share and use all over the world. But if we don't have advances in our rules, say that limit the catch in a fishery along with technological advances, those new technologies could do more harm than good.

In the developing-world context, the problem is often that the rules prevent valuable technologies. One I talk about a lot is just electrical light in the house, a hundred-year-old technology that still isn't available to many poor people all over the world. There -- that technology is not being made available to them because of the local rules that prevent it. And so I switched from thinking about how can we invent new improvements beyond electrical light, to thinking about how can we have improvements, innovation, diffusion of better rules alongside of innovation and diffusion of better technologies.

MALLABY: So in other words, the very fact that there are a lot of technologies that have existed for a long time, but yet are not actually adopted, suggests that it's the conditions for adoption that might matter more than the technologies themselves.

ROMER: Yeah, absolutely. And it's easy to think, oh, well, the poor people can't afford new technologies. But if you look at something like water, this ancient technology for delivering municipal water through pipes and taps, that technology's cheaper than the ones that poor people pay to get their water delivered to them in most slums around the world. So it's not that people -- poor people can't afford to pay for some of these modern technologies, but something deep in the system is preventing the development of something like a municipal water system that provides lower-cost, safer water.

MALLABY: Safer than having the water brought to you in some plastic container that --

ROMER: Yeah, plastic jug from a truck, from an unknown source.

MALLABY: Right. Right. Right. I mean, you use a very arresting image to get this point across sometimes, which is this photograph of kids doing their homework in an African city under a street light. And the kids probably have cell phones?

ROMER: Yeah.

MALLABY: Which is a newer technology than electric lighting. But they obviously do not have electric lighting at home. Otherwise, they would be doing their homework at home.

ROMER: Right.

MALLABY: So I guess this leads to the question, you know, people have observed for maybe 20 years, at the World Bank and other development organizations, that governance is very important, that rules matter, that institutions matter.

ROMER: Mm-hmm.

MALLABY: The question is: How do you actually encourage countries to improve their governance? I mean, and that's where you have some ideas as well.

ROMER: Yeah. Sure. So one suggestion I'm making at every opportunity is, let's take that word "institutions" and just stop using it. It's just too confusing and it's too vague, so think about rules. And when you -- every time you think about rules, think about laws and social norms about what's right and wrong. So the challenge is: How can we take an existing set of laws and norms, and change them to get to a new set of laws and norms?

I think one of the problems in the debate is we focused too much on the laws; we didn't think enough about the importance of norms. I think we also tended to assume that when there were bad rules in place, we wanted to look for a bad person to blame; like who's the bad person in charge? Who's the elite that's stifling opportunity for others? Let's find a bad person to blame, and then somehow change that person, and then we'll get to good rules. And I think that is just a dead end. It just doesn't correspond to the facts.

What we see are collections of people who all behave according to a given set of rules, and it's simply not possible, even for the leaders, to unilaterally change those -- change those rules in context. So we've got to figure out why is it hard for all these people, who can see that there are better rules, to not be able to change their rules, and then historically, what has actually worked to allow a change in rules when the -- kind of the frontal assault often fails.

MALLABY: So what's the answer?

ROMER: So the answer, I think, is this notion of a startup, where some group of people who are willing to try something differently say: Let us go off by ourselves. We'll develop both different laws, perhaps, but importantly, different norms about right and wrong. We'll reinforce that in our little culture that operates separately. And then, if these turn out to be a success and be better, we'll not only demonstrate to others that there's something which is better, but we'll also provide a mechanism where people can move from the equilibrium where one set of rules and norms prevails to this other one.

They can get socialized into those new rules, especially the norms, by exposure to them. And in a voluntary way without any coercion, you can move from one set of arrangements to another set of arrangements that are radically different, but at each step along the way, nobody was forced to change what they were doing here and adopt immediately what's working elsewhere.

MALLABY: So an analogy here would be between charter cities that you advocate in developing countries and charter schools in the United States. So one approach to school reform is to try to, you know, persuade people on the board of education to vote for a different -- choose a different superintendent and have, you know, reform from within.

ROMER: Yeah.

MALLABY: And then the alternative is to say that's really difficult because the existing school system sort of has a set of norms that are quite difficult to shift. So let's try reform from without through charter schools that sort of start out with new sets of norms.

ROMER: Yeah. So if you think about something like a KIPP school, it would be very hard to get a consensus with any existing school to shift this very different style of instruction and interaction with students at a KIPP school. But if you start a brand new one and say this is how it'll be run, students and teachers will go and try it out. But the charter schools lesson also has a caution for us, which is, I think, that if you don't operate at the right scale, you're not going to succeed.

I think that for dramatic change in education, you need to think at the level of a bigger system that probably is the scale of a city. So you need to change the whole governance structure, schooling in the city and how you measure performance and how you train people there.

So if you create these start-ups in a way which is too small and they're too dependent on the rest of the environment within which they work, they may be doomed to failure. And we've seen many countries around the world try to use this entity that they call a special economic zone, where they liberalize or change the rules in those zones, give firms the option to opt in there, so it has the elements I was describing before. But they're not self-sufficient; they're too dependent on the surrounding systems. And so they can't by themselves get the kind of success you could get if you took a city, which I think is, in many cases, the right unit to think about for doing things in a self-contained, comprehensive way.

MALLABY: And -- so another analogy is with the way that change takes place within business, and, you know, when IBM builds up a business, which is very, very good at selling big mainframes to corporate customers, and then along comes the personal computer and you've got to suddenly sell to individuals. It turned out that they had a lot of difficulty changing their business culture to be nimble enough to sell to individuals. And so another company sprung up from somewhere else, Dell or whatever, right?

So is that another good analogy with what you're --

ROMER: Yeah. There's -- I think there's a very fruitful analogy between cities and corporations, and they operate in an environment where they're competing with each other and start-ups can sometimes do things that the existing organizations can't do. And it helps, I think, guide certain intuitions that come to mind when we think about political change.

One of the very common reactions I get about a charter city is if you start at a brand new city with a particular set of rules, it might not succeed, it might not be a success like Hong Kong. To which my answer is, that's exactly right and we should start a number of them, just like we should start many small start-up firms. So the transition to the, you know, the computer on your desk and then the computer in your pocket, we think can remember the ones that succeeded; we don't remember all of the dozens or more that tried and failed. But the point at the level of the industry, and it will transfer to the world as a whole, is the cost of the failures is really extremely low. And the benefits of the successes are enormously important.

So we should be as open to the idea of brand new cities that start out and try and do things differently as we are to the options for brand new firms. And the one other thing that makes this so easy to do right now is that we live in a time where the world is desperately short on cities. You know, 3 billion people live in cities right now. In the next 30 years, 50 years, another 3 billion people will move into cities.

So we need to do urbanization on a scale that humans have never done before, more than we've done in all of history. And then the other interesting thing about this time is that once we've done it in this century, things will pretty much be over; we'll never again have the chance to influence the worldwide system of cities because we're going to reach a maximum population on Earth this century. We're going to reach probably a stable percentage of the population that lives in cities.

So one way or another, we're going to establish the system of cities for the whole world this century. And why not use it as a chance to try some things differently, do some things better rather than just grow by accretion all the -- all the many -- in many cases, badly run cities that exist right now.

MALLABY: I want to make sure that people understand how differently you're proposing, because you're saying not merely that there should be new start-up charter cities. You're saying that the people who run these cities ought to be outsiders, people from outside the country precisely to try to escape the existing rule set. You need, for example, if it's going to be Nigeria, that a consortium of European governments show up and start to run a new city, which may teach Lagos what it's done wrong.

ROMER: Yeah. This approach is one that could be used in many different places. So we'll talk -- come in a second and about Honduras where what you're describing is, I think, exactly what people in Honduras are expecting, that other governments will come in and help set up the governance for the new city they want to establish in Honduras. So think of it as a partnership between Honduras and a number of other governments who can bring both institutional credibility and administrative experience on basic things like the administration of law.

MALLABY: And we should just say for those who don't read the Central American newspapers every day that Honduras passed a constitutional amendment last week, which opens the way towards creating a charter city in Honduras and inviting foreigners to come in and administer.

ROMER: So we'll come back and talk about the specifics there in a moment. But I wanted to say that even though that might be the right model for Honduras, think about India right now. India might have a model where they create, entirely through their internal resources, brand new empty spaces where a new administration could be put in place and a whole new city could grow up.

So this idea of chartering an entirely new city could be something that's done entirely within a country, as China did with -- (word inaudible) -- next to Hong Kong, but in much of the developing world you have countries that are very small, that don't have the kinds of central resources that a country like India might have or countries like Honduras or many countries in sub-Saharan Africa. And there are kind of strong partnerships that, I think, could be exploited, will be critical to success. And the historical model that's worth keeping in mind here is that of Hong Kong.

If you think of Hong Kong as a piece of China where the British said, we'll do a partnership with China; we'll come in, we'll set up a new city here, and we'll see which Chinese want to come and live under a very different set of rules; Hong Kong was an enormous success for the people who came there and ultimately a success that I claim was pivotal in helping encourage the transition to the rapid growth we've seen since the late 1970s in China.

So -- and to bring it back to Honduras, they're very open to creating a new city where foreign partners might have a very decisive say on what takes place there.

MALLABY: And, you know, if one was to ask them, why would you give up control over some chunk of coastal land so that foreigners can come and run it for you, why do you think their political system has just voted with, I think, almost a unanimous majority in the congress there to endorse this idea? It's just counterintuitive that a country would hand over a chunk of land to foreigners. Why do you think that's politically feasible?

ROMER: So -- yeah, let's be -- let's be frank. This is a country which had a change in the leadership of the country in the previous presidency which was very irregular. And some people called it a coup. Others have said, well, you know, this person was breaking the law. But they had -- they had a president that was forcibly removed from office, a transition president and now a new set of leaders who were elected in the regularly scheduled elections.

But they understand that if they go to a major sovereign wealth fund and somebody with experience in airports and say, come invest billions of dollars to build a major airport here in Honduras; they understand that on their own, they're not going to have the credibility to say we can promise you that you're going to be able to operate in a stable environment for the next 50 years and your rights as an investor will be protected and the health, safety, water, electricity, all these things will be managed relatively well; they simply don't have the credibility to make that commitment.

But they understand -- in a way, it's just like if I went to someone and said, look, I want to buy a house. I'm a good guy. Lend me -- you know, lend me a million dollars and trust me. It just -- it would never work. I mean, I give up sovereignty over my house to a judge, and I say to the judge, I'm promising to pay these guys back. If I don't pay them back, then you've got to come and take my house away from me. Giving away sovereignty over my house lets me do a deal with the mortgage leader I could never do on my own.

And the government in Honduras sees that they're in exactly that same position vis-a-vis this enormous supply of worldwide financial capital and technological experience that's extremely eager to find places to invest in things like infrastructure all over the world. But right now, they're kind of like me and the mortgage lender on our own. They just can't get the deal done unless there's somebody who could guarantee that both sides will stick to the terms of the deal.

MALLABY: Paul Collier at Oxford, and I guess to some extent Steve Krasner, your colleague at Stanford, have talked around this idea as well. So I think, you know, what they've observed is that a lack of credible rules has been a major impediment to development, to the attraction of inward investment, as you described.

And they've advocated various sort of steps short of what you're saying. In other words, you know, if you sign up for the World Trade Organization, you're effectively adopting binding commitments from outside to promise investors that you will have sensible rules on commerce. And that's a kind of commitment mechanism that proves you're serious. And you're saying, you know, let's go beyond that and just take a discrete chunk of territory and hand over the whole control for 50 years, for some long period.

ROMER: Yeah, yeah. I think it's -- given the importance of this problem and the importance of the gains from trade if we could facilitate these long-term investments from the rich and fast-growing countries, the gains are so large that we should be willing to experiment with a number of different mechanisms.

But I think if you look at attempts that have been made to do this and you look at what kinds of things went wrong, it gives you pause about the -- you know, sort of the simple solutions others have asked -- others have proposed.

Let me give you some examples. Singapore was very successful in developing a city within its boundaries, and they started to ask: How can we go out and develop other cities like this in other parts of the world?

So they developed an extremely large industrial park, really a small-scale city on Batam Island in Indonesia. They also tried to develop a very large site outside of Shanghai in China. And in each case, it wasn't that some government came in and just expropriated the physical capital that they had put in place, but there were a series of subtle changes -- it's what I call death by a thousand cuts -- which took opportunities, which were very -- well, in Indonesia, it was very successful for a while, and then the government changed certain parts of labor regulation and just destroyed the viability of these investments.

In China, it was the opposite case, where they had put in all the infrastructure in the ground and then no businesses were willing to come because the local governments were sending all these subtle signals about things that -- things could go wrong in this zone if foreigners came and invested in the Singapore zone instead of one the city wanted to develop.

And I'm told there were stories like, you'd show up at this huge industrial park that Singapore was developing, and there'd be a big pile of dirt on the road blocking entrance. And you'd call the local government trying to figure out, who do we get to move the pile of dirt, and nobody knew. And Lee Kuan Yew would personally call Deng Xiaoping and say, you know, who could -- who do I got to talk to to move that pile of dirt? And, you know, Deng Xiaoping doesn't have any clue.

So the kinds of ex -- post-opportunistic behavior you can get subjected to here is subtle and has a lot to do not just with the law, which is important, to be sure, but also things like just local administration, the competence of the civil service, the transparency of the civil service.

And so bringing in a country that has experience with transparent, open, visible administration, regulation and legislation can be a way to quickly to the equilibrium that will really provide confidence for the investors.

MALLABY: So, I mean, just to sum up here, so supposing we take Honduras as an example, and the argument is that, you know, for umpteen years, World Bank missions have visited Honduras, and they've said, you know, you've got a governance problem; you need to do various kinds of reforms to fix your rules so that you get a better growth. And the problem is the entrenched elites or the system in general is too ossified -- it's like IBM setting its mainframes -- and it cannot make this switch to a better equilibrium of better rules.

So now you say, okay --

ROMER: Although, let me make one slight nuance there. Think of this partly as two sides, both of which are very afraid of being taken advantage by the other side. So you've got people with historical claims to large amounts of land who feel very threatened by peasants who are talking about, you know, like land invasions and seizures of land.

On the other hand, you have peasants and low-wage workers who feel like the landowners have taken advantage of special access through the legal system to get a position that is unjustified and they may do even more. So it's not just ossification, but a real fear on either side that if you created some government entity with some power, one or the other side is going to grab ahold of it and use it to disadvantage the other.

MALLABY: Right. But so for complex political economy reasons, it's tough to get the reform that would really stimulate growth. The creation of the better rules is difficult. And we've tried this for a long time. So now let's think outside the box, and instead of trying to get the Honduran polity to reform itself, let's have this charter city -- like a charter school, let's start off a rival, where you have on this coastal piece of land a consortium, and it's the Swiss government, and in alliance with the Dutch and Danish governments. And they come in together. They've got extremely good rules in their own countries. They understand transparency. They understand rule of law. They have fantastic rules in this new city. And now they're going to attract all kinds of investment.

But isn't the threat of the pile of debt outside the charter city, put there by the jealous mayor from the local Honduran city, isn't that still there?

ROMER: So first, in the sequence here, part of how you get that transparency and you deal with a lot of the internal problems is that the Dutch and the Swiss -- and I forget who was your third, but they all agree to appoint an individual who is like the strong mayor, the executive, who has lots of discretionary powers, a very clear mandate, but whose job it is to get things done and hold that person accountable. So, strong executive leadership is very important.

MALLABY: Are you a candidate?

ROMER: No. (Chuckles.) Nobody who's been a university professor is a candidate for an executive position. (Laughter.)

MALLABY: Even the son of a former state governor?

ROMER: No. But then this gets back to my comment about why cities are important and things smaller than cities don't work. If this is on a coastal location, with its own port, with its own airport, its own power system, you could have literal walls to grow up on the border with the rest of Honduras, and this little entity becomes a self-sufficient city-state that thrives, just like Hong Kong thrived when mainland China was going through the cultural revolution.

And so in the conversations in Honduras, what the president and the members of Congress understand is they need to create an arrangement which is strong enough so that an investor says to him- or herself, my investment there will be viable, in the sense that my rights will be protected, but also in the sense that this will be thriving city, no matter what happens in Honduras. Even if there's, you know, revolution and violence and chaos in Honduras, this is big enough, this is self-contained, this will thrive no matter what.

MALLABY: I'm going to open up in a second to members. I'll just ask a final question, which is, what's the chances, realistically, that any developed country wants to take on this responsibility? Because you're sort of positing that they would actually resort to force of arms to defend this enclave if they needed to. Otherwise, it's not credible.

ROMER: Yeah. I think because of the recent experience in Afghanistan and Iraq, developed countries are going to be very hesitant about military commitments that in some sense they feel like they can't deliver on. But this is a commitment which is easy to deliver on, and I think it won't be hard to persuade people of this.

The line in the sand where someone has to invade across that line to cause a violation is extremely important because it so clearly signals the violation of the law, of international law. So think of the invasion by Iraq of Kuwait. It was not hard to mobilize people around the world, because this was wrong and had to be resisted, and it wasn't hard to push it back.

So that's not the problem. The problem that we face right now is when there's a group of people where the mission is to try and impose order on people where some of those people never asked for these outsiders to come in and use violence to impose order. And so I think it's a radically different situation where there are some people who have said, we want to live under these conditions where you help protect our borders; and, you know, we as citizens of the city will staff, you know, the national service entity that helps protect those things; we just need your commitment of, you know, freedom of navigation of the seas and, you know, a little bit of support.

That's a radically different situation than trying to go in and force a security or policing system on a population where some people might like it but the others become, you know, the rioters in Haiti right now or the National Liberation Movement that resists our presence in Iraq --

MALLABY: People in the city have voted with their feet. They've chosen to be there.

ROMER: Exactly. Everybody -- this is why Hong Kong had such a different experience than most other colonial ventures by the British; that everybody who lived there came there knowing full well what the arrangements would be, and those arrangements had a legitimacy, because of that choice to opt in, that anything that's imposed against people's will can never have.

MALLABY: Okay. Let's open it up. Who's got a question? Mitzi, here in the front. So please stand and state your name.

QUESTIONER: I'm Mitzi Wertheim with the Naval Postgraduate School. I started working for IBM the day they had their PC, and I watched this transformation. They transformed themselves by selling off things. And I'm -- a little unclear to me how cities can sell off things. That's just a question.

I also have a question about scale. And if you're going to create a new city, one of the things you have to have is an initial investment to build the infrastructure. And it's not clear to me where -- because that's substantial, whether it's electricity or whether it's sewage or whatever. Where does that money come from?

MALLABY: The financing question.

ROMER: Yep. And your questions are very closely linked. So let me take the financing one first.

There is an enormous amount of financial resources around the world that is very interested in infrastructure investment. They see this as exactly the kind of investment they want, guaranteed high returns for decades into the future. And these -- like these sovereign wealth funds and private investors have been totally burned by chasing the wave for the last -- you know, the last decade. So there's a huge amount of financial resources there.

What's missing is an environment where they can make those investments and be free of political risk. So the money is there if you can create the -- if you can create the political entity that would protect it.

QUESTIONER: (Off mic) -- right kind of people.

ROMER: Well, so then think about how this plays out. The airport, who would finance an airport? If this is going to be a city of 10 million people, lots of people would agree to finance the airport in exchange for the ability to just collect the landing fees there for both the passengers and the cargo that come through. Who would build the power system? You know, a firm that can charge for the electricity at the kind of rates we pay. Who would build the water system? So there's an awful lot of investment that could come in just based on self-interest on the part of the investors.

But what you need is a government which is strong enough to do two things: one, ensure that the initial deal that you make with the investors is respected from the side of the residents and the fee payers and the government; but on the other side, equally important, to guarantee that the firms stick to what they promise when they come in, because in many developing countries, they promise the world, they come in, they're the monopoly provider, and they say, oh, you know, I know we said X, but you're going to pay, you know, 2.5 times X or you don't have any water tomorrow.

So you need a strong government to protect, because both sides can behave badly in this kind of arrangement.

Now, one other thing. Who's going to pay for the schools here? Outside investors are not going to come in and pay for the schools. If you think about a tract of land, like a thousand square kilometers, which is what we're talking about here, it's about -- it's bigger than the size of either Singapore or Hong Kong; and you think about what that land would be worth -- it's worth nothing now, essentially -- you think about what that land would be worth if there were a city like Hong Kong or Singapore that was built there, it's just hundreds of billions of dollars in potential gain in the land itself, separate from what you have to pay for the buildings, the ports and power system and so forth.

There's a way to give the governing entity the returns on the value it's going to create in that land and use those returns as the way to pay for the basic services like policing and education, minimal health care, that make this a really attractive place to come to. So there's a way to do this that doesn't require any charity, that just harnesses mutually beneficial exchange, as long as we create an environment where people can safely contract with each other and do deals.

MALLABY: I should point out that in the U.S. foreign assistance context, we have two things going on right now: a big, announced desire to reform USAID and have new ideas, which is good for your idea; and a huge budgetary constraint, which might be good for your idea too.

Another question. In the middle.

QUESTIONER: Bob Winter with Arnold & Porter. What is the relationship between the new city-state and the rest of Honduras? And what happens if people join the city-state and then decide they really don't like it? And does the government of Honduras gain anything in the way of taxation, and therefore does it in fact have some control over the city-state?

And finally, trying to understand how this would operate in practicality, is the city-state run by an executive with, you know, a number of Danes and the like, or is it democratic? And if it's democratic, what do you do if you have the types of divisions within the city-state that you have in the rest of Honduras? And what leads you to believe that that will radically change?

ROMER: So let me work backwards again. All of this is under discussion right now. Very little of it is set in stone. To just be clear about the procedures here, there is a constitutional amendment which specifies what the Congress in Honduras can do in creating special development regions. And that specifies a few items about what are the powers of the Congress in that region as opposed to what would be the powers within the region. And the thrust of the amendment is to create enormous flexibility for some new government entity in that region to operate independently of the government.

So I guess I -- and now going back to your first part, things like fiscal transfers between the two have yet to be worked out. They haven't -- there's a second stage, where they have enabling legislation for a particular site, that will probably specify things like the involvement of partner governments in, say, appointing the strong mayor. And there may be some arrangements for fiscal transfers back and forth. They may decide that the smartest thing for Honduras and Hondurans is to not require any fiscal transfers at all and just make sure this thing right next to them is a big success.

Now, the Hondurans that I've spoken to think that in the early stages, it would be better -- it would be more attractive to Hondurans if, when they go to this city, they don't have a vote over who that executive in charge of the city is. So both some of the rich land-holding families who might want to invest there, some of the peasants who are landless and very frustrated about that, both sides may find it more attractive to go to a place where they know that the mayor was picked by the Danes and the Swiss rather than selected through some democratic process which could lead to one side taking advantage of the other side through, you know, patronage and militias and all the kinds of things we see around the world.

So the people in Honduras will make this call, but they may say not only will the foreign investors be happier if there aren't elections for the mayor in this place for many years; the firms who come in and hire people may also be more comfortable; the residents may actually be more comfortable, as well, going some place where they don't inject the kind of insecurity they've had to live with for so long in Honduras in this new place.

MALLABY: So when you go there, you don't get a vote, but by virtue of having gone there, you have already voted with your feet.

ROMER: Yeah. And by the way, I think it's absolutely essential for any country who sets up something like this, and for the world as a whole, to insist on not just a de-jure but a de-facto exit option for people, that no one should ever be trapped in one of these places. So they vote with their feet to come in, but they should always be free to leave if they don't like what they find.

MALLABY: Instead of the choice that cross-border migrants make all the time. They leave Honduras; they don't go to a charter city because there isn't one; they come to the United States, they don't get to vote here, at least at first, and they've chosen that. They've opted in.

ROMER: Yeah. I mean, if you think about the choice right now, a Honduran who comes to the United States typically has to leave his family behind -- suppose he's going to come work in construction. He leaves his family behind. He's going to live illegally in the United States, has no hope of voting for who the mayor is wherever he lives in the United States, and he's got a one-in-seven chance of being kidnapped and held for ransom by a Mexican gang on the transit to the United States.

So it's not very hard to imagine that a place close by, where he could take his family, where he could live as a permanent resident and have the same kind of economic opportunity he's seeking in the United States -- it's not very hard to imagine it being preferable to go to that place as opposed to come to the U.S. the way they do now.

MALLABY: Yeah, a question right here.

QUESTIONER: Hi. Rebecca Patterson, the Kauffman Foundation. I was just wondering if you could talk about the opting-in process, if there is some sort of selection criteria that you can -- you prevent spoilers.

ROMER: Again, this is something where the Hondurans will have to make their own choices. There are a few things that economic theory suggests going in. There's an issue like the one we face about health insurance and pre-existing conditions. You would be dangerous to start this by saying, well, for example, we guarantee that we're going to provide very large transfers for anybody who has some kind of disadvantage, because what happens is then you select a whole population that are committed to transfers.

In the same way, it'd be a disaster to say, "Well, we, the Honduran government, are going to give a whole bunch of tax concessions and payments for firms that will come and create jobs," because then what you do is attract a whole bunch of firms who are committed to, you know, bad equilibria with -- you know, with transfer payments and rent-seeking from the government. So you've got to set these rules up so that the people who come in come in because they want opportunity and they want to -- they want to work.

When you think about security issues, another question that I've raised is whether or not they want to think about, in some sense, the burden of proof when you ask someone to leave to be different from the burden of proof when you say, why not incarcerate someone for violating the law?

And I think they may well opt for the notion that, in principle, this city is available to anybody from Honduras, and they're committed to the idea this -- that this will be for the whole region as well, but that there may be conditions for coming to this place, like participation in something like national service, and conditions in terms of attachment to the workforce or going to school. And if you don't meet those kinds of conditions, you may just be asked to leave. You know, they might decide it's simply not an option in this city to be unemployed and not in school and just a source of -- a source of potential problems.

MALLABY: Another question. Fred here.

QUESTIONER: Thank you. Fred Tipson with the U.N. Development Program here in Washington. I wanted to ask you whether you'd looked at Jeff Sachs' Millennium Villages approach. But actually, I lived in Hong Kong twice, and I -- the analogy is fascinating, but it strikes me as --

ROMER: To what year? What years?

QUESTIONER: I was there from -- let's see: (1988/1998 ?) -- '91 and then '98 to 2001. So ten years apart.

ROMER: So ('88 ?) to '91.

QUESTIONER: Both before and after the transition.

ROMER: Okay. So you had -- okay. (Inaudible.)

QUESTIONER: Yeah.

But the question is really which analogy to Hong Kong's history is the relevant one. Because, as you know, in the beginning, the Scottish trading houses were the ones -- and the conditions for people were abysmal for, you know, most people in Hong Kong except for the British civil servants.

But then if you're talking about the take-off period, really so much depended on the influx of these powerful families from Shanghai who ran the businesses. And, of course, Hong Kong was a managed economy by the British -- still is a managed economy. And the notion of local people just had a whole -- you know, there -- a lot of people were in transition when I was there. People were getting their green cards to be able to have an exit strategy. It's a city that was -- that basically for the take-off period was building on the ability to manufacture in China, very cheap labor, almost forced labor conditions that entrepreneurs in China were able to take advantage of.

I just don't see these analogies coming true in Honduras. But I know you've probably thought deeply about the analogy and how it -- how maybe it does instruct how this can be done more effectively.

ROMER: Yeah. Yeah. I think the right -- the right picture to have in mind is Hong Kong in 1950, because then the prospect of the takeover by mainland China was very distant, so everybody was anticipating British administration. And this was a place where somebody from mainline China could come and get their first paying job, their first job with a wage -- and that's almost always in garment assembly -- I mean, we just see this over and over again all around the world -- then later into something like toys, light manufacturing. I mean, most of us in this room can remember what "Made in Hong Kong" meant when we were -- we were kids.

Those people didn't earn very much. They lived in tiny apartments. But that job and that apartment was a big step up for them from what they had on the mainland. And that job in particular, especially a formal-sector job with a firm that pays a wage and follows rules and enforces certain kinds of patterns of interaction with other people in the firm, there's a training -- an on-the-job education that comes from that kind of job, which is incredibly important for people who want to improve their quality of life.

So I think we have to be very open to the -- to the -- to the economic reality that the first jobs that most people will hold in, say, this new city in Honduras will be jobs that pay very little to be competitive with the worldwide garment industry and light manufacturing. They're going to live in tiny apartments, by our standards, fewer meters per person than we would -- we would ever want for ourselves.

But when they go there, they'll be telling us they're going there because that's better than the other options they've got, and because they know that there's a future like the future for all the -- virtually all the Chinese who went there in the 1950s who all rode the wave up into incredibly rapid increases in average income per capita.

MALLABY: But you could extend the point, I think, because if the analogy is Hong Kong in 1950, then by the time Fred moves to Hong Kong in the late '80s and there is -- then this interaction with Shenzhen and the building up of the hinterland and the interaction between the capitalists in Hong Kong and the sweatshops, and if that's -- that's also part of the vision here -- right? --

ROMER: Yup.

MALLABY: -- that the charter city ultimately does create spill-overs into the hinterland which are going to be good for the hinterland.

ROMER: Yeah. But, you know, and who knows how long it might take, but 20 years, 30 years, this charter city in Honduras might look like Hong Kong today or New York today, and there won't be any garment assembly or any toy manufacturing going on there, but it will now be a service and cultural and finance center which is serving other locations where people will still be going to get their first job in manufacturing. And those could be other locations adjacent to this location in Honduras, but it could be other locations that are just a plane ride or a ship ride away throughout Central America.

MALLABY: Right over here. You've been very patient. Thank you.

QUESTIONER: I'm Maureen Lewis from the World Bank. And I like out-of-the-box thinking, and I think this really falls under that category. And it's a very interesting idea.

I do have a couple of worries, having spent some time in Latin America.

One is that I gather there will be courts, but there don't need to be any jails, because you can send people away. I mean, it -- that's sort of a shorthand. But --

ROMER: My guess is there probably will be jails, too.

QUESTIONER: There will be jails. Okay. So you do have that cost.

But I think fundamentally I worry about two things.

One is the economic -- the economic viability of it depends on labor, basically, because you're going to bring in the capital, and you have the land, so that there's a little bit of a constraint there, given the problems that Honduras has had in the past in terms of a labor force that is not really prepared particularly well. And the garment -- the garment industry is very competitive worldwide. It's really hard to break into that, for many reasons that you can probably explain to me better than I can explain. That's one.

But the other issue that I do come back to is the political stability and what the guarantees are for investors against political upheaval. All it takes is a Chavez, and today you have this gleaming city, and tomorrow you're, you know, at the mercy of somebody who really is not going to abide by any of the rules that a previous government agreed to.

ROMER: So you have to -- you have to kind of scenario plan for something like this. So -- this won't happen, so I can use his name, but you know, Michael Bloomberg agrees that being president is really not very interesting, and Michael Bloomberg takes over and he's running this -- he's running this new city in Honduras. He gets to build a brand-new city from scratch.

And he's got commitments. He's appointed by the Swiss, the Canadians, the Norwegians. He's got investments that brings in the infrastructure and then the firms.

And remember, this isn't just a problem of getting access to cheap labor. The thing about cities is they create enormous value when they're well-run. So you're getting all of these gains from bringing millions of people in and letting them interact with each other really, really intensely. So that's the value he's creating.

And then Chavez takes over the rest of Honduras. You know, Bloomberg goes: Fine. You know, cross the border -- you better be shooting when you cross the border, because you can't come in. And he just -- he keeps running his city; goods are coming in and out of the port; planes are taking off, flying in and out, just like Hong Kong during the Cultural Revolution. You know, what's the problem?

Chavez says: Well, we -- you know, we tore up the old constitution. This is our land.

Bloomberg says: Okay. Well, what are you going to do? Drive across the border shooting?

MALLABY: I think it's worth sort of underlining a point you, I think, were getting at earlier --

ROMER: Yeah.

MALLABY: -- that there's a hierarchy of international commitments, some of which are violated very, very easily --

ROMER: Yup.

MALLABY: -- and don't have much credibility, and others to do with clearly demarcated borders. In fact, the record is that when people violate those and they come across shooting --

ROMER: Yeah.

MALLABY: -- then there is an international response.

ROMER: Yeah. I mean, the reason I'm sort of being provocative about this is that people don't -- I mean, almost nobody, except for, you know, Saddam Hussein in Kuwait, has tried this ploy recently. The only other one was the Argentines trying to take back the Falkland Islands.

So it's really implausible that any -- you know, that any leader in any surrounding region would try and mount a military invasion, because even countries who hadn't, say, signed on as, you know, people who help appoint the mayor are going to react to such a -- you know, such a brazen attempt at, you know, violating, you know, the sovereignty or the integrity of a political jurisdiction.

So I think what you should worry about are not the invasions but the subtle -- kind of the potential for death by a thousand cuts. And so, you know, this is exactly what people are talking about in Honduras right now with the constitutional amendment. Constitution reserves for the government of Honduras control of the air -- the air rights over this -- over this area. That can't be delegated under the constitution without more changes than they wanted to make to the -- to Bloomberg. So Bloomberg can't control air traffic over his city.

But Bloomberg can go out and sign treaties with many nations around the world that guarantee free passage of air traffic, just like the treaties we use that guarantee innocent passage through maritime waters. And then if the Chavez-like leader wants to say, well, our air traffic guys aren't letting any planes take off in and out of your -- you know, in and out of your city, well, now he's got a beef with nations all over the world because he's violating treaty commitments to all of them, not just an internal dispute with this -- with the city. And then -- you know, then what's to stop Bloomberg from just saying, you know, we've got our own air traffic controllers now; we direct the planes when to take off?

So you can -- you can scenario plan fairly specific kinds of circumstances here, but the overriding thing you can come back to is that there's no economic reason why a city like this couldn't be set so that it can be totally viable regardless of what happens in the rest of Honduras. And so if you plan for what would happen if the rest of Honduras plunges into chaos, then you can be confident that actually it'll never happen. Yeah.

MALLABY: (Inaudible) -- in the back.

QUESTIONER: Hi. Amanda Sloat. I'm intrigued by the idea, but it seems if you take a more cynical approach, it smacks a bit of postmodern colonialism, that you have an underdeveloped country and so you have a bunch of wealthy Western nations with spare capital looking for an easy place to make money and have the cheap labor and come in and effectively build a town off the back of a poorer country. So I'd be curious to hear your response to that

And second, how some of these governance arrangements actually work. I mean, you've used the example of Hong Kong, but that was effectively a British colony, and so there was a sense of British ownership or responsibility for what happened there. And in your scenario with Michael Bloomberg, if Honduras sinks into conflict, who's responsible? I mean, if it's attacked, is it some, you know, NATO Charter 5 issue if there's a Michael Bloomberg and the U.S. is on board? Militarily, who responds? I mean, I -- it's not going to be the Swiss. Is it -- is it going to be the Danes or somebody else?

And what happens if your Michael Bloomberg viceroy, you know, becomes sort of a despotic character who's doing untoward things in the city-state? Who's then responsible for overseeing him and removing him if he becomes problematic?

ROMER: Yeah. So on the first question, we often use words to invoke a feeling without necessarily focusing on what the words mean.

So think about the case of those 75,000 Hondurans each year who migrate to the United States at great risk to themselves, at huge financial cost, serious risk to their personal security and a very unattractive legal status when they get to the United States.

Is that postmodern colonialism, that they want to come live under the kinds of conditions that we want our children to have available for where they live and work? You can call it postmodern colonialism, but I don't see what it buys you. If people want something, I think we should give them the choice and let them decide for themselves what's right for them. And the tragedy right now is there's no place nearby that people can go without risk of being kidnapped, take their families, live legally, know that their kids will get an education. And it can't possibly be a bad thing to create some more choices like that, given the ones that Hondurans are already making.

Now, the other practical question you alluded to is who makes sure that Michael Bloomberg doesn't misbehave? That's built into the basic law, so not the constitutional amendment, but the basic law, which we anticipate will have a structure where there are representatives on some kind of a board -- like somebody nominated by the Swiss, somebody nominated by Canada, somebody by Denmark, who appoint the mayor, hold the mayor accountable, make a decision about reappointment. So it's, in many ways, it's just like the kind of arrangement we have with Ben Bernanke. He's got a lot of freedom to do stuff on a day-to-day basis, but there's a clear mandate for what he's supposed to accomplish and a clear provision for reappointment for selecting a successor.

So this is not at all like suggestions that we revert to some form of authoritarian rule. This is absolutely built in from the beginning, democratic accountability for this chief executive. But that doesn't have to mean democratic accountability in the sense of a locally run election. There can be other representatives, other democracies that hold an executive like this accountable. And as I said before, if there is a real threat, I think it's much more likely to be the kind of threat that, say, drug gangs present in Mexico right now or that Chavez presents in other countries, which, to a large extent, are just open intimidation through threats of physical violence, which you have to prevent by a security force that makes sure that that's never a successful strategy.

The other thing which we're seeing just pervasively is manipulation of the political system by the drug gangs, by Chavez and the like. And so part of what might make people more comfortable to go to someplace where the mayor was appointed by the Danes and the Canadians is they know that it's not going to be subverted by enough money from the drug gangs or the Chavez types.

So I think it's likely to be a very attractive arrangement in a part of the world where things are very, very unstable right now.

MALLABY: Okay. We've got time for one more question. Before we take it, I want to remind people that this is on the record. And we'll go over here for the last question. Wait for the microphone, please.

QUESTIONER: I hope this is fair, I'm related to the speaker.

MALLABY: Yes, yes. Perhaps you could tell everybody who you are. (Scattered laughter.)

QUESTIONER: As an observer of the American political scene, as a governor and as the chairman of the national Democratic Party, I am very interested in this fact that this out-of-the-box idea is being pushed by Honduras that changed its constitution. It didn't talk about it; it did it last week. That is in an atmosphere in which this nation, for years, has been trying to do its own form of intervention and economic development, which has a pretty bad record.

It would seem there is a real, should be a real audience in this country for another way at least to contrast.

So my question is -- because all new ideas that come to this city are given a pretty hard time -- the question is, is our posture to be, sit back and let's see what happens? We'll watch them, you know, go their way and join five years from now? Or do we have an obligation or an opportunity as a group of organizations in a nation that care about change to create a more viable alternative? In short, in one sentence, I'm fascinated that the driving force this particular week comes from Honduras as contrasted to the United States.

MALLABY: Well, the question from Governor Romer to Professor Romer was actually maybe a question for the rest of the people in the room, but if you want to take a last minute or so to just wrap it up, that would be great.

ROMER: Well, let me just say one fact here, which is that this idea started first in Honduras. People there were talking about the idea of could they persuade a nation to establish an embassy in Honduras where the grounds of the embassy would be several hundred square kilometers and they were hoping that somehow the international law of embassies would mean that they would have extraterritoriality and could set up a new city there in Honduras.

So that was the discussion that people there in Honduras were having when they heard about the more abstract discussions I'd been having about charter cities. So they came to me and they've taken some things I've suggested and they've, you know, modified, rejected other things that I've suggested. But this is something which is coming from the people of Honduras who really desperately perceive the need to vote, initiate growth, but make sure that growth is inclusive and get past histories -- a history of animosity and fear in their country, which has just been holding them back ever since the first European contact.

So I think -- my view is that if I can answer your question, I think we should be ready to be as helpful as we can. The world doesn't have enough experiments and enough places where a country says, we're willing to try something different. So I hope I've persuaded at least a few of you to keep an open mind about being receptive to what they're doing and maybe even being helpful.

UNAUTHORIZED REPRODUCTION, REDISTRIBUTION OR RETRANSMISSION CONSTITUTES A MISAPPROPRIATION UNDER APPLICABLE UNFAIR COMPETITION LAW, AND FEDERAL NEWS SERVICE, INC. RESERVES THE RIGHT TO PURSUE ALL REMEDIES AVAILABLE TO IT IN RESPECT TO SUCH MISAPPROPRIATION.

FEDERAL NEWS SERVICE, INC. IS A PRIVATE FIRM AND IS NOT AFFILIATED WITH THE FEDERAL GOVERNMENT. NO COPYRIGHT IS CLAIMED AS TO ANY PART OF THE ORIGINAL WORK PREPARED BY A UNITED STATES GOVERNMENT OFFICER OR EMPLOYEE AS PART OF THAT PERSON'S OFFICIAL DUTIES.

FOR INFORMATION ON SUBSCRIBING TO FNS, PLEASE CALL 202-347-1400 OR E-MAIL INFO@FEDNEWS.COM.